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Lessons from a decade of failed austerity

Getting it right this time
Report type
Research and reports
Issue date
Key findings

A decade on from the global financial crisis, the British economy faces increased risk of renewed recession. Alongside weak domestic growth, global economic growth is at its weakest since the crisis and the risk of a no-deal Brexit remains high.

Any preparation for recession must involve learning the lessons of the government response to the last one.

This paper shows how the cuts imposed after the last recession, both in the UK and in much of the developed world, harmed economic growth, with a heavy impact on workers’ pay.

Overall, pay growth has halved across OECD countries in the decade since the GFC. In real terms, annual pay growth has been below one per cent a year for two thirds of countries.

Policymakers and politicians wrongly attribute this entirely to ‘productivity’, despite a failure to find convincing supply-side explanations for the change in growth at a time when controversial policies are acting on demand.

Calls for government expenditure in the face of renewed recession are already widespread, but ‘austerity thinking’ still constrains the options for fiscal policy going forwards.

Recommendations

  • The government should ask for an independent review of how the Office for Budget Responsibility and Bank of England judge the impact of government expenditure on the economy, assessing the critical assumptions on multipliers, the output-gap and the ‘NAIRU’ given the international experience of the austerity decade.
  • Immediately deploy fiscal policy to support aggregate demand according to this changed view, expanding government (current) expenditure on public sector salaries and services.
  • Fast-track increases in public infrastructure spending to the OECD average of 3.5 per cent of GDP.
  • Increased expenditure should be financed by borrowing rather than increased taxation in the first instance. This is not equivalent to deficit spending, as a stronger economy will improve the public sector finances.
  • Use fiscal policy as part of a wider plan to deliver sustainable growth across the UK, including investing in the public services families rely on, the skills workers need for the future, a just transition to net zero carbon emissions, and giving workers a real voice at work. 
Summary

A decade on from the global financial crisis, the British economy faces increased risk of renewed recession. Alongside weak domestic growth, global economic growth is at its weakest since the crisis and the risk of a no-deal Brexit remains high.

The political and policy context is evolving. In the UK and other countries fiscal policy is on a more expansionary setting, and there are calls for formalising a more enhanced role.

These changes are welcome. But ‘austerity thinking’ still constrains the options for fiscal policy going forwards. There is no sense that austerity was the wrong policy; the media still demands ‘how will it be paid for’ of any spending announcement; and policy recommendations by international organisations are still conditioned on faulty ideas of ‘fiscal space’.

For example, the Institute for Fiscal Studies simply add recent spending announcements (of £13.4bn) to existing estimates for government borrowing. Austerity thinking is the logic of the household budget and omits the impact of government policy on the economy.

On a macroeconomic view government spending strengthens the economy and can improve rather than damage the public finances. Over the past decade, increased public debt ratios demonstrate operating this thinking in reverse.

This paper shows how the cuts imposed after the last recession, both in the UK and across most advanced economies, harmed economic growth, with a disastrous impact on workers’ pay.

On average, pay growth has halved across OECD countries in the decade since the GFC. In many countries the standard of living is at best static. Jobs growth has been relatively robust, slowing only moderately, and above one per cent annually on average. In the UK there is now a fundamental challenge: for too many, work is no longer providing a way out of poverty.

Policymakers and politicians wrongly attribute this entirely to ‘productivity’, despite a failure to find convincing supply-side explanations for the change in growth at a time when controversial policies are acting on demand.

On a global view the wider policy mix of fiscal restraint and monetary ease has also led to renewed imbalances. Growth has been unduly reliant on external demand; global private debt has expanded while austerity has not resolved public debt.

Rather than take the crisis as an opportunity to do something different, long-standing policy agendas have been intensified. The perceived needs of finance and the wealthy have been put first. Even as spending was supported to get out of crisis, austerity was championed as the other end of policy. Labour markets have been further deregulated, protections and benefits withdrawn, and a greater element of coercion imposed. On the other hand, wealth has been supported by QE and various subsidies directed at the financial sector (chapter 1).

A decade later, nothing is resolved. Austerity has weakened economic growth much more than expected; and public debt is not reduced. Moreover, the fragilities that led to the global financial crisis (GFC) are not resolved. While the dangers are widely understood, policymakers have not been able to prevent resumed private debt inflation on a global level.

But worse still, there is no admission of failure. The analytical technique used to assess outcomes assumes policy is not at fault. This results in failures of demand in the economy being interpreted as failures of supply.

The report sketches out labour market outcomes across the OECD (chapter 2) and then focuses on an alternative technique to assess directly the impact of reduced government spending on the economy.

The approach is largely based on charts of aggregate OECD experience and individual country performance, with UK outcomes emphasised throughout. Generally, growth is compared before and after the crisis, because in austerity policies (for most advanced economies) have operated on the growth of government spending. Some data are included in an annex for reasons of manageability.

Labour market outcomes are understood in the context of changes to growth of the expenditure and income measures of GDP. The analysis shows how the impact of cuts to government spending have significantly damaged rather than improved overall growth. With domestic demand reduced there has also been a relatively greater reliance on global trade, which is partly motivated by QE (chapter 3). The income measure of GDP motivates an explanation of how productivity is effect not cause of outcomes, and the implications for capacity – i.e. the output gap and ‘NAIRU’ – are addressed (chapters 4 and 5). Rather than operating near capacity, the world economy has been greatly contained for a decade.

Periodic efforts to tighten monetary policy expose ongoing financial fragilities, and hence the longer-standing vulnerabilities arising from private not public debt (chapter 6). These are symptomatic of the longer-standing orientation of the economy towards wealth and speculative ventures rather than productive activities.

The social imperative for immediately increased public expenditure and strengthened worker protections is equally a macroeconomic imperative (chapter 7). Broad recommendations for an expansionary fiscal policy are set out:

  • The government should ask for an independent review of how the Office for Budget Responsibility and Bank of England judge the impact of government expenditure on the economy, assessing the critical assumptions on multipliers, the output gap and the ‘NAIRU’ (non-accelerating inflation rate of unemployment’) given the international experience of the austerity decade.
  •  Immediately deploy fiscal policy to support aggregate demand according to this changed view, expanding government (current) expenditure on public sector salaries and services.
  • Fast-track increases in public infrastructure spending to the OECD average of 3.5 per cent of GDP.
  • Increased expenditure should be financed by borrowing rather than increased taxation in the first instance. This is not equivalent to deficit spending, as a stronger economy will improve the public sector finances.
  •  Use fiscal policy as part of a wider plan to deliver sustainable growth across the UK, including investing in the public services families rely on, the skills workers need for the future, a just transition to net zero carbon emissions, and giving workers a real voice at work. 

In the wake of the crisis, policymakers merely intensified a failed model. A decade on, the debate should concern how to aim the system at the needs of workers and businesses, rather than the wealthy and finance. A longer perspective shows that we have done much better in the past (chapter 8).