1981 and the 364 Redux
Late last year the Uneconomical blog asked ‘are we still stuck in 1981?’. As we head towards the Budget the parallels are stacking up. As I noted earlier this week, more and more economists are calling for a capital spending based, debt-funded, fiscal stimulus (since I wrote that post the chorus has been joined by Vince Cable and the Economist magazine). We have not quite reached the level of 364 who wrote to Geoffrey Howe demanding a change of course in 1981, but we are well on the way.
Yesterday the Prime Minister invoked Margaret Thatcher’s ‘there is no alternative’ argument to justify sticking with his failed macroeconomic policies.
It is certainly possible that those close to the Prime Minister and Chancellor believe that by not changing course now, they will be hailed as iron-willed politicians who rode out public opinion to deliver a better economic outcome in the future. Simply put, they may be thinking, “just stick to austerity now, don’t admit anything has really gone wrong and when the economy eventually recovers we can say how right we were all along. It’ll be just like the early 1980s”.
There are many problems with this argument. As Martin Wolf argues in an excellent column in today’s FT, the economy today is in a very different place to where it was in 1981. There is much less room for monetary policy support to the economy now (rates fell from 17% in 1980 to 8.5% in 1984 as Wolf notes today) whilst households are much more indebted today than in the early 1980s.
Or take government borrowing costs as a point of comparison. Back in the early 1980s these were around 10%, today a ten year gilt yields 2.1%. As Citi have argued:
The government’s borrowing costs are negative in real terms, and it surely is possible for the government to find projects that will yield a positive real return — and hence would be self-financing over time.
Yesterday Cameron argued that the government can’t rely on a ‘magic money tree’. This is undoubtedly true – but negative real interest rates coupled with the possibility of self-financing capital investments are as close to a ‘magic money tree’ as a macroeconomy will ever get. This was not the case in 1981.
Another difference with the early 1980s is the pattern of change in real household disposable income. The current squeeze is historically unprecedented. Real disposable income fell in 1976 and 1977, but rose strongly in 1978 and 1979, after a small fall in 1981 and a weak growth in 1982 it once again grew relatively quickly until the mid 1980s. Real household income growth is unlikely to be anywhere near as strong in the next few years (see for example the Resolution Foundation’s real median wage forecasts). Unlike in the early 1980s we can’t rely on a pickup in incomes to boost consumption spending.
But perhaps the biggest problem with those close to the Chancellor taking comfort from the 1981 Budget debate is the fact that the 1981 Budget was not a success.
It is now relatively common for people to ask questions such as ‘how did the 364 economists get it so wrong?’, but in reality they didn’t.
As Stephen Nickell (one of the 364 in 1981 and now on the board of the OBR) argued in 2006:
It is now a commonplace view that the 364 were wrong to complain because, shortly after writing the letter, the growth rate of real domestic demand and GDP in the UK switched from negative to positive. As it happens this view is incorrect. As one of the 364, I would say that wouldn’t I, so in what follows, I pursue this question by analysing the periods before and after the sending of the letter. I conclude that the 364 economists were perfectly correct to complain about the macroeconomic policy of the day back in 1981…
The main complaint of the 364 economists in their 1981 letter was that macroeconomic policy was unnecessarily tight and that it would deepen the depression. By ensuring that subsequent output growth was below trend for a number of years, it did indeed deepen the depression just as predicted.
Nickell is surely correct to argue that just because the economy grew in the early 1980s does not mean that policy was not too tight.
A similar point could be made today. The most recent consensus of independent medium term macroeconomic forecasts (as collated by the Treasury) point to growth of 0.9% in 2013, 1.7% in 2014 and 2.1% in 2015. If (as with any forecast, this is a big ‘if’) those forecasts turn out to be correct, George Osborne will be able to look back at the end of 2015 and say, ‘in early 2013 many economists urged me to change course but since then the economy has grown by around 4.5%. I was right after all’.
This is a nonsense argument. Our recovery is extremely weak whether one chooses to compare it to the initial government forecasts, to the experience of other leading countries or to our own history. Those arguing for a stimulus at the Budget are not saying that without a stimulus we will face perpetual contraction, what they are saying is that a stimulus now would lead to a quicker recovery, lower unemployment and better economic outcomes than would otherwise be the case.
The worry now is that growth expectations are so weak, and the public so accustomed to bad economic news that any growth will be hailed as a sign of success. The fact that some people are seeking comfort in the experience of the early 1980s is a reason for concern.