The UK economy is recovering. The government is vindicated. Its critics should crawl into a hole. This, in essence, is what George Osborne, the chancellor of the exchequer, claimed in a rousing speech delivered earlier this month. In particular, he argues, Plan A has worked. Those who have been advocating a Plan B – slower fiscal tightening – have proved to be wrong. Here, then, is my response.
Yes, the economy is recovering. But the performance since Osborne took office in May 2010 has been dismal. Over three years, the economy has grown by a cumulative total of 2. 2 per cent. In June 2010 the Office for Budget Responsibility forecast that the economy would expand by 8.2 per cent between 2010 and 2013. The real figure may end up being a third of that. In the second quarter of this year, gross domestic product was still 3.3 per cent below the pre-crisis peak and 18 per cent below its 1980-2007 trend – the slowest British recovery on record.
Financial crises do cause havoc. That explains some of this awful performance. But Spencer Dale and James Talbot of the Bank of England have shown that UK performance is dismal even by the standards of other crisis-hit, high-income economies. The eurozone has performed as badly as the UK. But, given the mess there and the UK’s control over all policy levers, that is hardly something to boast about.
Osborne can (and does) point to a strong labour market performance. This has been a saving grace for Britain. Had the UK enjoyed normal productivity performance, unemployment might now be more than 15 per cent. Unemployment has remained low because labour productivity has now fallen back to 2005 levels. That is hardly something to boast about.
Osborne responds that fiscal policy did not cause the dismal underperformance. That was due to inflation shocks and the eurozone. Since Osborne was a cheerleader for the eurozone’s austerity, he cannot wash his hands of all blame. But the more important point, as Simon Wren-Lewis of Oxford University has pointed out, is that the debate is not about what caused the unforecast slowdown. What matters is whether the economy has been weaker with austerity than without it.
Little doubt exists over the answer to this question. With interest rates at the zero bound, austerity weakened the economy relative to what might otherwise have happened. The question is only how much it has done so. It is impossible to know counterfactuals. But Oscar Jorda and Alan Taylor of the University of California, Davis, concluded that in 2013 UK GDP will be about 3 per cent smaller than it would otherwise have been. Is that right? Nobody knows. But it is in the right direction.
Oh no, it is not, proponents of austerity respond. This ignores the fact that the program delivered credibility and lower interest rates. In the febrile circumstances of 2010, when people thought, foolishly, that the UK might become Greece, that view might have made some sense. But it soon became clear it did not. In June 2010, the OBR forecast cumulative net borrowing of £322 billion between 2011-12 and 2015-16. In March 2013 this was up to £564 billion. In June 2010 the structural current budget was forecast to be in surplus by 2014-15. By March 2013 this had slipped two years. In June 2010 the ratio of public sector net debt to GDP was forecast to start falling in 2014-15. By March 2013 this had moved back to 2017-18. The peak level of net debt also jumped from 70.3 per cent to 85.6 per cent of GDP. Yet the impact of this slippage on long-term interest rates was zero. Only improved prospects for recovery and so of earlier rises in short-term rates raised longer-term rates.
So the chancellor had other options. As I have argued before, he could have stuck to the same plans for current spending, while temporarily lowering rather than raising value added tax. He also could have taken advantage of low borrowing rates to increase rather than reduce public investment. In fact, he is too hard on himself. He has allowed the fiscal position to slip and used the public balance sheet to support investment and the housing market. Call it Plan A minus. But he could certainly have been more deliberate and aggressive about it.
To this the chancellor would reply that none of this matters because the economy is recovering strongly anyway. Moreover, he insists, his critics thought this was impossible. But nobody thought recovery would never happen under austerity, merely that it would be damagingly delayed. The politics of this policy may not be too bad for Osborne if the unnecessarily slow recovery becomes a faster bounceback in the run-in to the 2015 election. But it is hard to see an economic case for it.
One thing ought to be quite clear: the fact that the economy grows in the end does not prove that needlessly weakening the recovery was a sound idea. This has been an unnecessarily protracted slump. It is good that recovery is here, though it is far too soon to tell its quality and durability. But this does not justify what remains a large unforced error.
Copyright The Financial Times Limited 2013.