Let’s call it failure

John Lanchester looks at the nation’s finances

Saying ‘I told you so’ is supposed to be near unbeatable fun, so it’s disappointing to report that, in the case of the government’s handling of the British economy, speaking for myself, no fun is being had. As George Osborne’s autumn statement made clear, the scale and speed and completeness with which things are going wrong are numbing. The Tories went into the 2010 election with a manifesto commitment to reduce the structural deficit – the amount by which the government’s spending in any given year exceeds its income, excluding temporary effects from the downturn. The first point in their economic policy read as follows: ‘We will safeguard Britain’s credit rating with a credible plan to eliminate a large part of the structural deficit over a Parliament.’ How? It’s on the next page: ‘We will cut government spending to bring the deficit down and restore stability.’

That’s what they set out to do. In June 2010, in his first budget, Osborne said the structural deficit was 4.8 per cent, and that with three years of reduced spending, the figure would be down to 1.9 per cent. So how’s that going? Well, by the end of those three years, after £59 billion of tax rises and spending cuts, the figure is set to be 4.3 per cent. Even that number was achieved only thanks to a kitchen sink’s worth of special inputs, including a £3.5 billion windfall from auctioning off the 4G telecom spectrum, and some exuberant, almost rococo creative accounting to do with the transfer of Royal Mail pension liabilities, state ownership of the Bradford and Bingley building society, and interest credit from the Bank of England’s quantitative easing scheme.[1] All the tweaky accounting is in the government’s favour, obviously. (The Royal Mail transfer is a particular goody: the pension fund’s £28 billion in assets are transferred to the government, meaning a sudden boost to its books, even though the liabilities are transferred too, meaning that the taxpayer is now going to have to make up the fund’s significant deficit. So we’re now on the long-term hook, but who cares, as long as the government gets a short-term boost to the balance sheet, and another medium-term boost to the balance sheet when the Royal Mail is sold off to a private buyer, a process which is going to be much easier now that it’s no longer liable for its own employees’ pensions.) If you reverse the creative accounting and add the interest from the quantitative easing back where it used to be, as a Bank of England asset, it adds 0.6 per cent to the structural deficit. That takes it back up to 4.9 per cent – higher than it was when the coalition came to power. Osborne’s single biggest economic ambition was to get the deficit down, but he hasn’t managed it, and has had to abandon his noisily announced target to get rid of most of the deficit in a single parliament. Gather round, children, and take a good look. This is the thing we call failure.

It’s not just that the news has been bad for quite a long time; it’s that the news was already bad and has been getting worse. Osborne’s budget back in March was an immediate political disaster. (The current set-up for a spring budget and an autumn statement, brought in by Labour in 1997, is that the former sets out the prospects for the economy and the government’s spending plans, whereas the latter reports on how the economy has been doing since the budget, and makes adjustments accordingly.) The maxim for budgets has historically been that when they look clever in spring they look mistaken by autumn, and when they look misjudged in spring they have begun to seem more astute six months later. This year bucked that trend. The 2012 budget brought us the poor-bashing pasty tax, the oldster-bashing granny tax, the chaotic and technically flawed partial abolition of child benefit, the rich-bastard-favouring cut in the 50 per cent income tax rate; all these combined to make as self-evident and immediate a cock-up as anyone could remember. Six months later, it looked even worse.

That’s because the economic outlook has continued to darken. One of the first things Osborne did as chancellor was to set up a new body, the Office of Budget Responsibility, independent of the Treasury (notionally independent, anyway), with responsibility for coming up with an impartial assessment of the government’s fiscal and economic position. He did that largely because the Treasury’s estimates for the economy had for years been consistently and embarrassingly wrong. The embarrassment wasn’t just in the fact of their inaccuracy but in the fact that they were always inaccurate in the same direction, favouring the government of the day. The OBR was set up to correct that tendency. To run it, Osborne brought in Robert Chote, who had been head of the Institute for Fiscal Studies, a highly respected think tank which analyses government tax and spending plans and reports on them in a spirit of Cassandra-meets-Scrooge. In June 2010, the OBR predicted that the UK economy would grow by 2.8 per cent in 2012. By this year’s budget in March, it had revised that estimate downwards to 0.8 per cent. By the autumn, the new guesstimate was that the economy would shrink by 0.1 per cent this year. The OBR predicts that the economy will shrink again in the last quarter of the year, before slowly picking up in the first quarter of 2013. If they are right about the first part of that guess but wrong about the second – which looks far from improbable – then we will have entered a historically unprecedented triple-dip recession.

It’s worth taking a moment to think about what these wrong forecasts mean. The Treasury earned a reputation for tweaking its predictions to suit the government of the day, but the OBR was set up with the explicit ambition of not doing that. In the words of Danny Alexander: ‘We set up an independent Office for Budget Responsibility because we did not want forecasts that could be interfered with by politicians, as they were in the past.’ So why does it look so much as if that’s what’s happening? A cynic would say that the Treasury thumbprint is all over the OBR: it’s run by a Treasury appointee, staffed mainly by civil servants seconded from the Treasury, funded by the Treasury, and reliant on Treasury data, so why wouldn’t its forecasts be as government-friendly as the Treasury’s discredited ones used to be? But I don’t think it’s as simple as that. Forecasts of this sort are as public and as transparent as it’s possible for them to be, and reputations are at stake, and the problem of the over rosy prediction was the whole reason the OBR was created. Taking these factors together, I think something else is at work. A wonk’s pride is a powerful thing, and just as wonks love being proved Nate Silverishly right, they equally hate being shown so publicly to be wrong.[2]

That other factor might well be the same as the one identified by the International Monetary Fund earlier in the year. It concerns a technical economic factor called the multiplier, and that in turn involves us in a discussion of what GDP is and how the economy works. Imagine for a moment that you come across an unexpected ten pounds. After making a mental note not to spend it all at once, you go out and spend it all at once, on, say, two pairs of woolly socks. The person from the sock shop then takes your tenner and spends it on wine, and the wine merchant spends it on tickets to see The Bitter Tears of Petra von Kant, and the owner of the cinema spends it on chocolate, and the sweet-shop owner spends it on a bus ticket, and the owner of the bus company deposits it in the bank. That initial ten pounds has been spent six times, and has generated £60 of economic activity. In a sense, no one is any better off; and yet, that movement of money makes everyone better off. To put it another way, that first tenner has contributed £60 to Britain’s GDP. Seen in this way, GDP can be thought of as a measure not so much of size – how much money we have, how much money the economy contains – but of velocity. It measures the movement of money through and around the economy; it measures activity. If you had taken the same ten quid when it was first given to you and simply paid it into your bank account, the net position could be argued to be the same – except that the only contribution to GDP is that initial gift of £10, and if this behaviour were replicated across the whole economy, then the whole economy would grind to a halt. And that, broadly speaking, is what is happening right now. People are sitting on that first tenner.

Richard Feynman was once asked what he would pass on if the whole edifice of modern scientific knowledge had been lost, and all he could give to posterity was a single sentence. What axiom would convey the maximum amount of scientific information in the fewest possible words? His candidate was ‘all things are made of atoms.’ In a similar spirit, if the whole ramshackle structure of contemporary macroeconomics vanished into thin air and the field had to be reconstructed from scratch, the sentence which packs as much of the discipline into the fewest possible words might be ‘governments are not households.’ The principles of running an economy are in many crucial respects different from those of keeping your own finances in order. The example of the hypothetical tenner is part of the reason why: governments need to keep money moving around. For a household, to deposit the money in a savings account might well be the most sensible course. Governments, on the other hand, need that velocity – they need GDP. In order to get it, they sometimes have to borrow that first tenner, which they can do in a range of ways not available to ordinary citizens (who can’t, for example, just print the money). Once that first tenner is spent, the government’s hope is that it will continue to be spent many more times.

The ‘multiplier’, both the process and the number, were a central preoccupation of Keynes’s. About thirty years ago, when Keynes was in the depths of economic unfashionability, going up to a group of macroeconomists and trying to start a conversation about the multiplier would have been roughly like going up to a group of astrophysicists and trying to start a conversation about your star sign. The multiplier was so far off the agenda that it was no longer considered a serious economic principle. With the Great Recession (or, as the Chinese never fail to call it, the ‘Western Financial Crisis’), that has changed. Keynes is back on the agenda and the multiplier is back as an issue not just of interest but of pressing concern. When governments adopt austerity packages and spending cuts, they are deliberately taking on the multiplier effect of their own spending. They are betting that the multiplier effect is less important in the overall scheme of things than the savings made by not spending that initial tenner. To that end, they use economic models which put a precise value on the multiplier, and calculate the effect of spending cuts accordingly.

But what if they’re wrong? What if the effect of public spending cuts is bigger than they thought, bigger than they have allowed for in their models? What if, quite simply, they’re using the wrong multiplier? If that were the case, then austerity policies would be doing more damage than good, and the countries that were pursuing them would be digging themselves further and further into a recessionary hole. The amount they’re saving in spending cuts would be more than accounted for by the extra damage they were doing to themselves. And guess what: that’s exactly what the IMF thinks has been happening. In the October edition of its regular World Economic Outlook, the IMF studied the question and announced that governments had been basing their calculations on the effects of austerity using a multiplier of 0.5. So for every £1 billion removed from government spending, GDP would contract by £500 million. The IMF looked at the relevant historical data, and concluded that the real multiplier for austerity-related cuts was higher, in the range of 0.9 to 1.7. So that same package of £1 billion in fact removes as much as £1.7 billion of output. This was a jaw-dropping thing to discover, not just because it was surprising in itself, and because it explained the surprising-to-governments economic damage being done by austerity packages, but also because the people saying so were the IMF. The very same IMF whose off-the-shelf policy recommendations for indebted governments and struggling economies always, but always, involves swingeing packages of spending cuts. In terms of the surprise, and its source, the IMF announcing that the multiplier effects of spending cuts had been underestimated was like the BMA announcing that they had studied all the relevant evidence and come to the conclusion that exercise is bad for you.

The fact that the people in charge of recommending huge cuts in public spending don’t, at this basic level, fully understand the economic effect of those cuts, is surprising only if you’re unfamiliar with just how little certainty there is in the world of macroeconomics. (An alternative single-sentence summary of the entire field would be ‘nobody knows anything.’) Some of the things that are happening in the British economy at the moment are not at all easy to understand. We have had a double-dip recession, first from the first quarter of 2008 to the second quarter of 2009, with the economy contracting by 6.3 per cent, and then again from the end of 2011 to middle of 2012, with the economy contracting a further 1 per cent.[3] It grew by 1 per cent in the third quarter, boosted by numerous one-off factors and especially by the Olympics. At the moment, according to the OBR, the best guess is that it is contracting again, and will finish by being 0.1 per cent down on the year. But the truly weird and not at all understood fact is that this self-same economy has been energetically producing jobs. In the quarter to October, in the middle of this Stygian economic gloom, the British economy added 82,000 jobs. That’s an all-time quarterly record. From the normal economic perspective, this makes almost no sense. A shrinking economy that’s creating work at a rapid rate? It’s so counterintuitive that the first candidate for an explanation would normally be a mistake in the data. But the figures seem clear and robust: unemployment peaked at the end of 2011 at a fraction under 2.7 million, and has now fallen to a fraction over 2.5 million. What the hell?

These are not for the most part high-quality jobs: much of the new employment is part-time and low-paid. This helps to explain another troubling aspect of the current situation, which is that productivity – the amount produced per worker – is 15 per cent lower than it would have been if pre-crash levels of productivity were projected forwards. That’s a big fall, especially given that recessions normally see an increase in productivity, since employers try as far as possible to do the same amount of work with the minimum necessary number of workers. The OBR response to Osborne’s autumn statement has a special section on what it calls the ‘productivity puzzle’, and doesn’t come up with a firm conclusion, other than that ‘it is unlikely that any single factor fully explains the fall in productivity.’ In terms of the future outlook for Britain’s economy, in increasingly competitive global markets, falling productivity is exactly the opposite of what we need.

Crouch down for a closer look at the economy, and the murky waters grow murkier still. Let me suggest here that we separate two terms that are used near interchangeably, ‘cuts’ and ‘austerity’. Here I propose to use ‘cuts’ to mean specific budgetary cuts leading to specific cuts in services. ‘Austerity’, on the other hand, I’ll use to mean a general reduction in overall levels of government spending. Cuts first. We can all agree that there have been savage cuts to public spending. Examples are not far to seek: the police have lost more than 24,000 jobs since the coalition came to power; more than two hundred libraries closed in 2011 alone; local councils are on a four-year track which will see their budgets cut by more than a third. The evidence of these cuts is apparent more or less everywhere in the UK, in the first instance usually through those shrunken budgets in local government.

There was so much gloomy news in the autumn statement, and the OBR report was so complex, that the main piece of bad news in it has gone largely unnoticed. Because the coalition has ringfenced spending in health, schools and overseas development, the cuts needed to achieve the public spending targets all have to come from non-ringfenced departments. That means job cuts – lots and lots and lots of job cuts. In the last quarter of 2008, total public sector employment was 6,058,000. At the moment, it stands at 5,860,000.[4] This means that in the four years since the crisis hit the public sector has lost 198,000 jobs. Public sector employment has fallen for 11 quarters in a row. Here, though, is the bad news: the OBR predicts that from a starting point of 2011, by the beginning of 2018, the economy will have lost 929,000 public sector jobs. That means there are more than half a million public sector jobs still to be cut over the next five years. ‘All this implies an average fall in GGE’ – General Government Employment – ‘of just under 30,000 per quarter over the remainder of the period.’ That’s 10,000 public sector jobs going every month: more than 330 people being sacked every day, or (given an eight-hour workday) one public sector worker being sacked every ninety seconds for the next half-decade.

Is this achievable? Could any government do that? No government in British history has, which should give us a clue. The cuts to unprotected, unringfenced departments, in real terms (that means adjusted for inflation), would amount to more than 30 per cent. The Institute for Fiscal Studies thinks it is ‘inconceivable’ for the implied levels of cuts to be achieved. In the LRB of 11 March 2010, when the cuts to unprotected departments were set to be 18 per cent, I quoted an IFS economist as saying that ‘for the Ministry of Defence an 18 per cent cut means something on the scale of no longer employing the army.’ Upgrade the level of cuts to 30 per cent and the cuts are, I suggest, politically and practically unachievable. To truly cut public spending, the coalition will have to go after targets which it has explicitly ruled out cutting: health and schools. Those areas of spending are both still growing in real terms. Pensioners haven’t been explicitly protected from cuts, but they have in practice been shielded, principally because they possess a magic power undreamed of by the young: a willingness to turn up at the ballot box on general election day. Since hospitals, schools and pensioners taken together represent the vast majority of government spending, it isn’t possible to achieve a real reduction in spending without tackling all three of them.

If the coalition wanted real austerity policies, that’s what they would be trying to do. But whereas the cuts are real, austerity, in the sense in which I’ve defined it, is, once you look at the figures, less easy to locate. We’re undergoing sharp reductions in overall levels of government spending, yes? Well, actually, no we aren’t. There are reductions compared to the previous rates of spending growth, sure, and there are sectorally specific cuts also, but the figures for total government spending, as given by the OBR, go as follows: 2012-13, £674.3 billion; 2013-14, £719.9 billion; 2014-15, £731.0 billion; 2015-16, £744.7 billion; 2016-17, £755.1 billion; 2017-18, £765.5 billion. There’s a simple point to make about these numbers: they go up. The population is predicted to go up too, so they don’t represent a dramatic spending increase, but they do represent an increase and therefore, as some right-wing commentators (especially in the lively economic blogetariat) are pointing out, this is not austerity.

The question is: why does the government make such a point of emphasising its commitment to austerity if public spending is still going up? Since austerity is wildly unpopular with large sections of the electorate, and plays straight into a version of events in which the Tories are always and for ever the poor-bashing nasty party, why not instead just say, well, actually, public spending is going up, so there? The reasons are to do with politics rather than economics. At the time of the last election, a right-wing ideologue remarked to me that this was a potential ‘inflection point’ in the public consciousness, a moment comparable to Mrs Thatcher’s election in 1979, when she rode a wave of opinion thinking that the state needed to shrink; or Tony Blair’s in 1997, when the wave of opinion was flowing the other way, towards an acceptance of the need for increased public spending. This, he argued, was another such moment: a majority of people thought that, or could be sold the idea that, public spending had got out of control and needed to be brought back in order, via cuts and austerity. There was, he argued, a perceptible change in mood.

One striking piece of new evidence appears to support this claim. The most recent edition of the British Social Attitudes survey, the 29th, came out in September. It shows that attitudes towards welfare are hardening, and only 28 per cent of people agree with the proposition that ‘government should spend more on welfare.’ During other recessions, the number of people agreeing with that statement has gone up: we see others struggling, imagine our-selves in their shoes, and think they could do with a bit of help. In the last Tory recession of the early 1990s, for example, 58 per cent of people agreed with increased welfare spending. That the figure has fallen so steeply since, and is not rising during the current hard times, does indeed make it look as if an inflection point has been passed.

Right-wing mythopoesis on the subject of welfare seems to have worked. In effect, the Tories have been saying that the trouble with the poor is that they have too much money. This negative image of welfare – of ‘dole scroungers’ living a life of ease and luxury, blithely turning down work because they prefer a life on benefits – contains no reality, and the single most important fact about the welfare bill is largely absent from the debate: the fact that two-thirds of the welfare budget is spent on pensioners. Since pensioners have been protected from the spending cuts, this means that any reduction in the welfare budget must be drawn from the working-age population. A large fraction of this group are in work but so poor they still attract benefits. If these things were better known, the debate about welfare would be more nuanced, but the Tories clearly think that this shift in attitudes gives them a useful, potentially election-winning, stick with which to bash Labour.

Another factor helps explain why the Tories are so keen to stress the ferocity of their austerity policies. According to the governor of the Bank of England, the squeeze on living standards is the hardest since the 1930s, with inflation rising more quickly than pay, in addition to benefit cuts and tax rises. (A view with growing support is that the most damaging of the tax rises was the hike to 20 per cent VAT.) Almost everybody is feeling the pinch. People don’t like the idea that welfare is an easy option; people want to feel that those on benefits are feeling the pinch too. Austerity-speak is comforting to people worried about their own finances. And there’s one additional benefit for emphasising the mood-music of austerity: it helps placate the ‘bond vigilantes’ on the international debt markets, who are always on the watch for the faintest wavering in a government’s ability to repay its debts. By looking so fierce about austerity, the government is at least to some degree helping to keep down the cost of its borrowings. That matters, because it is having to borrow so very much: £80 billion this year, a figure which would be £28 billion higher if it weren’t for the aforementioned transfer of the Royal Mail’s pension liabilities to the state. To give some perspective on that £108 billion of borrowing, the total take from all income tax is £155 billion: so the government isn’t far off having to borrow as much money as it raises in income tax. If its borrowing were to become more expensive, in the way that Greek or Italian or Spanish debt has, the government would have a serious problem, so stressing austerity, as part of a determination to get the public finances under control, is a cheapish way of exerting some agency. Take all this together and you can see why the coalition is so keen on talking up the idea of austerity: it gives Labour a political headache, it placates the ‘squeezed middle’, it sucks up to the bond markets. Its achievability is a different question, and its desirability or advisability a very different one again.

Put all these factors together, and the British economy makes an extraordinarily complicated picture. We have an economy which is either flatlining or going into an unprecedented triple dip, but is rapidly growing jobs; we have brutal cuts in government spending, while government spending continues to rise; we have a country where things feel as if they’ve been bad for a long while, and yet on the figures, most of the hard times are still ahead. The Mayans were wrong to believe that the world would end in December 2012, but on the other hand, they were right to think that things would look pretty grim.

[1] If your old analogue TV has recently stopped working, that’s because the television channels have been kicked off that part of the electromagnetic spectrum in order to free it for 4G data.

[2] Not that Silver is always right. His team at FiveThirtyEight.com followed the UK election of 2010 in detail and developed a fancy statistical model to cope with the vagaries of our first-past-the-post constituency-based three-party electoral system. His eve-of-election prediction was Tories 312 seats, LibDems 103, Labour 204. Result: Tories 306, Lib Dems 57, Labour 258. Silver was noticeably undefensive and unparanoid about admitting the mishap, and blogged about it at endearing length.

[3] These are new numbers: the OBR has recrunched the data and concluded that the first part of the recession was both shorter and sharper than had been thought.

[4] Note for wonks: I’ve added 196,000 to this number to reflect the fact that 196,000 higher education jobs were moved from the public to the private sector in this quarter’s data.