Martin Wolf: Britains Experiment in Austerity

MW:

Britain’s experiment in austerity: Between 2010 and 2015, the UK is forecast to have the third largest reduction in the share of government borrowing in national income among 29 high-income countries: only Iceland and Ireland are to cut more.... Yet the UK has had no fiscal crisis. That makes its austerity remarkable.... So what explains the UK’s striking austerity? The starting point must be the size of the deficit itself. In 2010, the UK’s share of headline borrowing in national income was the third highest among the high-income countries, after the US and Ireland.... The UK’s fiscal accounts show a sudden surge in government spending and a modest fall in revenue, relative to gross domestic product.... [W]hat made the ratio of spending to GDP jump so quickly was the unexpected fall in GDP....

It is essential to understand the assumptions made by the UK government in deciding its fiscal strategy.... First, the government decided that a substantial part of the GDP lost in the crisis would never return.... The second assumption is that the ratio of spending to GDP should be brought back to around 40 per cent in 2014-15... well below the average... under Margaret Thatcher and John Major. Such levels of spending are a reflection of political and social values, not economic necessity.... Third, the government is determined to raise the ratio of receipts to GDP back to pre-crisis levels.... Fourth, the government has decided upon two new fiscal rules: a cyclically adjusted balance in the current budget by the end of the forecast horizon and the aim of lowering debt as a share of national income between 2014-15 and 2015-16.... Finally, and perhaps most important, the government decided that, given what it saw as a large risk of a meltdown in confidence in UK public finances, it had both to set out and start implementing its fiscal plans at once... the publication of good fiscal intentions would be insufficient... voters, having short memories, would be more inclined to forgive front-loaded cuts than backloaded ones.

The result, then, was these exceptionally tough fiscal plans. The government had alternatives.... I have emphasised the risk that a rapid withdrawal of fiscal support would reduce not just actual GDP, but prospective growth, via its negative impact on investment in physical and human capital. But a bigger question still arises: what is the longer-term plan for the economy’s supply-side? How is the economy to grow? That will largely determine whether what lies ahead is a short period of misery or a prolonged era in the doldrums. It is the question I plan to address this coming Friday.