23 March 2015

Paul Krugman is wrong about the UK and borrowing


Paul Krugman once did something or other quite good on the economics of trade, winning him the Nobel Prize. He also wrote some rather good stuff in the 1990s about the euro and about how Japan might escape its then-malaise. Quite a lot of orthodox economists were (and remain) fans of his writings on these topics. But regarding his analysis of government deficit reduction programmes and the options European governments in particular have had – and more specifically about how, regardless of how much they might have been borrowing they should always borrow more…not so much.

Krugman’s latest sally into European politico-economics is to bewail the state of “Britain’s Terrible, No-Good Economic Discourse” in the run-up to the General Election. He tells his unfortunate American readers that “economic discourse in Britain is dominated by a misleading fixation on budget deficits” and that “media organizations routinely present as fact propositions that are contentious if not just plain wrong”.

US readers should be aware that his “analysis” drifts between being contrary to the facts and being nonsense. Let’s start with the stuff he says that is contrary to the facts. Setting aside for now whether such a fixation would be “misleading”, economic discourse in Britain simply isn’t dominated by a fixation with government budget deficits. Most weeks the finance pages and economics articles in the politics pages of British newspapers are filled with the latest Greek crisis, falling oil prices, whether wages are rising faster or slower than the cost of living, how much further unemployment has fallen, what’s happening to inflation, when the Bank of England might put up interest rates, energy price freeze policies, and the latest round of banker-bashing. Sometimes we even read about spending cuts — e.g. the recent debate about cuts to defence spending. But the Budget deficit hasn’t really been an important issue since 2013, aside from brief passing flurries of interest at the Autumn Statement or Budget when the government announces its latest forecasts.

Next we don’t in Britain spend much time, any more, on the question of what caused the economic crisis of 2008. That may still fascinate Krugman, but folk in Britain have lives and everyday concerns. Almost no-one in Britain claims or believes that high spending by the last Labour government caused the economic crisis of 2008. They may well believe that Labour failed to regulate the banks properly. They may believe that, with the benefit of hindsight, Labour was running too high a deficit at the height of a boom in 2007. Some of us might even explicitly argue that it was a mistake for Labour to have promised, in the 2007 Comprehensive Spending Review, to have raised spending as much as it did and then to stick with those spending rise plans in 2008-2010 even when the recession started. And it is absolutely, demonstrably, as a matter of accounting not some clever economic theory, the case that the rise in the deficit from 2008 onwards was a rise in spending as tax receipts fell. But almost no-one in Britain thinks it was the rise in the Budget deficit from 2008-2010 that caused the recession of 2008-2009.

Next Krugman asks: “wasn’t Britain at risk of a Greek-style crisis, in which investors could lose confidence in its bonds and send interest rates soaring?” He says “There’s no reason to think so.” Well, I’d agree that Britain was not, in 2008, like Greece. What it was like, then, was Ireland and Spain – both AAA-rated countries in 2008 with modest government debts but large banking sectors and construction sectors that went bust. In April 2010, just before the UK 2010 General Election, government bond yields in Spain were below those in the UK. But subsequently both Ireland and Spain had serious second-phase economic collapses, with their governments being de facto bankrupted (in the case of Ireland) or near-bankrupted (in the case of Spain) by government bailout guarantees to their banking sectors. In 2010 it is absolutely the case that the UK faced a similar risk. Furthermore, if the UK had continued to run budget deficits at the 12% and more of GDP level it originally scheduled for 2010, it could very quickly have become like Italy – and eventually even Greece – as well. Krugman can assert that that was not a genuine danger until he’s blue in the face (in his mind it’s not possible for any country that prints its own currency to have a sovereign debt crisis – cos, like, the UK didn’t have a sovereign debt crisis in 1976 and, you know, everyone wants to lend money to Angola because it prints its own currency?). In Britain most folk simply don’t believe him. That is not because our economic debate is impoverished. It’s because he’s manifestly wrong. And he can claim that if we had run a 15% of GDP deficit, a 20% of GDP deficit – who knows? A 99% of GDP deficit – then he knows growth would have been faster in the UK. But the rest of who study these things know that there is not one single instance in pre-2008 history of a developed economy running a 12% of GDP deficit, but plenty of examples of countries running smaller deficits than that, then facing disaster

Next he claims that, during this Parliament, once growth did not match expectations, “Prime Minister David Cameron’s government backed off, putting plans for further austerity on hold (but without admitting that it was doing any such thing).” That’s just wrong. The Coalition government announced spending cuts and tax rises in the 2010 Emergency Budget. It announced additional spending cuts in 2011. It has not backed off or put on hold any of its aggregate spending cuts or tax rises. (Obviously it has modified tiny measures, such as the notorious “pasty tax” on which there was a U-turn in May 2012. But I don’t think even Krugman would claim reversing the application of sales taxes to hot takeaway food was central to Britain’s economic recovery.)

To be sure, although the government did announce some additional spending cuts and tax rises as the economy grew only poorly in 2011 and 2012, it did not announce so much additional spending cuts and tax rises that it returned to its original deficit reduction projections. But that was sticking to the original spending cuts / tax rises plan, not “putting austerity plans on hold”.

Indeed, that was a central purpose of the Coalition’s 2010 deficit reduction plan. Because it started early – without being forced to by bond market panic or by international agencies such as the IMF or the EU – the UK government has kept control of its own fiscal destiny. In many other parts of Europe, governments that did not have adequate plans in place in 2010 found that, when their economies grew poorly (or had double dip recessions — which happened in many other countries but not in the UK) they were forced to announce tighter deficit reduction plans. Precisely because the UK started early, when the economy grew poorly in 2011 and 2012 (which, incidentally, few people in Britain outside a few Krugman fan-club economists think was much to do with “austerity” — after all, we were running absolutely gargantuan deficits and structural deficits, creating huge stimulus, and printing money via QE big-time, which together led to 5% inflation in 2011, strongly suggesting even higher aggregate demand would have just meant even higher inflation) – when the economy grew poorly the UK government had the option of leaving its existing plans in place and not doing more. Krugman imagines that would have been an option if we had not started early. The experience of other countries strongly suggests that he’s wrong.

That leads me to a final point. Krugman wants his US readers to believe that all proper economists now agree that cutting deficits was a bad mistake, and it’s only self-interested finance types and ideologically-motivated politicians and think-tankers that take a different view. But that’s nonsense. Just think about it: “Everyone agrees that austerity was a mistake”… apart from every government in Europe except the Greeks, and the economists and many of the civil servants that advise them. Krugman and his fan-club do not constitute all serious opinion, much as they might like to regard themselves that way. It’s all very nice sitting in a US university office preaching to the Europeans (or, indeed, preaching in the New York Times). The Greek Finance Minister Yanis Varoufakis used to be such a US academic and part of that Krugman-ite anti-austerity set. But he’s very quickly found that in the real world things that were easy to preach about from afar prove rather harder to do when it comes to it.

In Britain, probably the most illustrious economist — and certainly the best-paid, which might tell you something about how effective he is – is Roger Bootle of Capital Economics. His latest Telegraph column is entitled “Osborne was right to take a tough stance on austerity”. That might give you some idea of what “serious economists” in the UK think. Perhaps an even more authoritative statement of European economic orthodoxy came from German Finance Minister Wolfgang Schaeuble who, in 2013, stated: “Nobody in Europe sees this contradiction between fiscal policy consolidation and growth”. I agree with Wolfgang.

Andrew Lilico is Chairman of Europe Economics.