When George Osborne imposed tough fiscal austerity in his first two years as Chancellor, he at least had an excuse. He could point to Greece and say: we must do whatever it takes to avoid that fate. Many economists at the time argued that eurozone countries were rather different from the UK, and we now understand much better why having your own central bank is the critical difference. But back in 2010 there were many who were worried by what was happening in the eurozone and supported the spirit if not the detail of Osborne’s plans.
Five years later, and the Chancellor wants to repeat the experience of those first two years by making it unlawful for the government to run budget deficits in normal times. On this occasion he has no excuses: there is no chance the UK will become like Greece. Seventy-nine economists have already written a letter denouncing the surplus plan, and both the Financial Times and the Economist have joined the criticism.
Why are economists against the idea? The Chancellor wants to bring government debt down rapidly. Yet economic theory is pretty clear that if you want to reduce government debt, it is generally best to plan to do this slowly. The costs of raising taxes or cutting spending today can easily exceed the future benefits that come from having to pay less interest because debt is lower.
However, Osborne rarely appeals to economic theory when it comes to fiscal policy, preferring household analogies involving credit cards. Yet even this does not work for him. We should pay off credit cards quickly because interest rates on credit-card debt are very high. In contrast, interest rates on UK government debt are historically low. Any business will tell you that the best time to invest is when borrowing is cheap. Now is the time to borrow to improve the UK’s infrastructure, but in order to achieve its surplus target the government plans to spend less on public investment than at any time over the past 12 years. So, how does the Chancellor justify going for surpluses? One argument is an old favourite of those advocating austerity: reducing the burden on future generations. Yet intergenerational equity hardly justifies reducing debt rapidly. Those who have suffered the most from the Great Recession are the young and it is they who will bear the cost of going for surpluses.
The second argument the Chancellor uses is that we need to be prepared for an uncertain future. It is important to decode what this means. He is not talking about a possible recession in the next few years, because the economics goes completely the other way. As the governor of the Bank of England, Mark Carney, has said, going for surplus will be a big drag on growth. He may be able to offset this by keeping interest rates low, but if other things go wrong the Bank will run out of ammunition. Going for surplus increases the chances of a downturn in the next few years, which is another reason why Osborne’s plans have angered many economists.
The risk that the Chancellor probably has in mind is not a mild economic downturn but another major crisis, like a new global financial crash. He wants the government to be able to run up large deficits in such a crisis and to have the resources to be able to bail out financial institutions once again. (The Conservatives may say the 2010 deficit was down to Labour profligacy but Osborne knows that is not true.) However, presumably the Chancellor also thinks that the banking measures he has implemented should prevent such a crisis happening in the next decade or two, so we are talking about something 30 or 40 years hence. In that case we do not need budget surpluses: modest deficits will be sufficient to cut the current debt-to-GDP ratio by half in 30 years’ time.
There is a quite different explanation for why Osborne is so keen to get to a budget surplus quickly. It is a great excuse for reducing the size of the state, particularly when you have pledged not to raise most taxes. Politically, this is best done quickly, to be well clear of the next election. This was what happened from 2010 to 2015: sharp austerity, followed by much more modest cutbacks and tax breaks. Even though the economy suffered as a result, he still won the election, so why not do it again?
How will Labour respond to Osborne’s surplus strategy? Some MPs want to capitulate completely: say they overspent before the recession and follow Osborne’s lead today. That is a frightening prospect, because it would leave the SNP as the only major party talking any sense about UK fiscal policy. (Ironically, this is the same party that tries to pretend, against all the evidence, that the immediate fiscal position of an independent Scotland would not be dire.)
The problem for Labour is that it keeps on making the same mistake on fiscal policy, which is to triangulate between sensible macroeconomics and what works well in focus groups. Just before and after the 2010 defeat, it should have made the positive case for ensuring recovery before worrying about debt. Instead, the message of “too far, too fast” just sounded like “austerity-lite”. And crucially, it failed to counter the narrative of past Labour profligacy, preferring to “move on”.
It is time for Labour to change the strategy to something completely different – to start telling the truth. To say that managing the government’s finances is different from running a household budget and that the deficit fetishism of the past five years has damaged the economy. Only that way can it avoid being tagged in five years’ time as the party that is always fiscally irresponsible.
Simon Wren-Lewis is Professor of Economic Policy at the Blavatnik School of Government, University of Oxford
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