Just like O Level French is enough to buy a pastry in Paris so an economics degree occasionally makes it possible to read a fairly dense economic text that opens the eyes. So it is with an excellent essay on the London Review of Books called ‘Let’s Call It Failure’ by John Lanchester that focuses on austerity and the economic multiplier.
Lanchester’s conclusion – ‘the scale and speed and completeness with which things are going wrong are numbing’ – is probably of little surprise, anyone having a quick look round Britain today could probably conclude that. But it’s the way he traces the Government pursuit of its objective to cut spending to bring the deficit down that is so enlightening.
Osborne’s aim was to cut the structural deficit from 4.8% to 1.9% after 3 years. Despite nearly £60bn of tax rises/spending cuts, the figure is set to be 4.3% and that is only achieved by a lot of what in local government we used to call ‘creative accounting’ – counting the windfall from 4G telecom licences (not yet sold), transferring Royal Mail pensions assets and liabilities (assets counted short, liabilities counted long) and the transfer of interest on quantitative easing from the Bank of England. Without these it would have been, guess what? 4.9%.
All that pain and no gain. And a triple dip recession on the horizon.
Lanchester pins much of the blame on a misunderstanding of the economic multiplier and that GDP is a measure not only of the amount of money people spend but the velocity with which successive people spend it. He traces a £10 note around the economy, being spent by one person then by the second person, then by the third. When it has been through six pairs of hands the initial tenner has added £60 to GDP. If instead the first person had put it in the bank, it would have remained £10. Our economy is sitting on the tenner – and the multiplier was the core of Keynes’ economic analysis of what to do in a recession.
Our Government, backed until now by the IMF, has put a value on the effect of austerity of 0.5% – that is, for every £1billion of public spending cuts GDP would contract by £500m. Good old IMF, having got it wrong in every poor economy they have ‘rescued’ over the last few decades – swingeing cuts, privatisation, one solution for every problem – now suggest the multiplier for cuts is twice as high and possibly 3 times as high. In short, austerity is exactly the wrong thing to do because cutting public spending disproportionally depresses GDP. And cutting the poor is the worst of all – more than anyone else, they spend their tenner and keep the velocity of circulation going.
And if you’d like more evidence of the deficit disaster, try this from a Conservative economic commentator, Ramesh Patel, on Huffington Post. Pulling no punches, he concluded: ‘The deficit myth is the grossest lie ever enforced upon the people and it has been sold by exploiting people’s economic illiteracy….. Cameron is playing the blame game to depress confidence and growth to justify austerity. Secondly, to use austerity as justification for a smaller state to gain lower taxes. Thirdly, to paint Labour as a party that can not be trusted with the country’s finances again. Therefore, we Conservatives will win a second term because people vote out of fear.’
Sounds like being in ‘deficit denial’ was the right thing after all.