From the TUC

Deficit Reduction vs Growth: A False Choice

29 May 2012, by Guest in Economics, Uncategorized

An opinion poll from new think tank Class this weekend found that, when asked about the priorities for economic policy, 95% of the public thought that ‘creating jobs and reducing unemployment’ and ‘encouraging economic growth’ were either fairly or very important.

However 85% of the public also thought ‘reducing the deficit’ was either fairly or very important.  (It’s worth noting at this point that whilst only 46% of the public thought ‘reducing the deficit’ was very important, ‘creating jobs and reducing unemployment’ was rated as very important by 77%  and 72% believed that of ‘encouraging economic growth’).

Some will ask, how can this be squared? The public seem to want a focus on jobs and growth, but they also believe that deficit reduction is important.

Personally I don’t see any contradiction here. I think that lot’s of the public ‘get’ the idea that the best way to reduce a deficit is to through faster growth and more jobs.

Indeed I’m still amazed at how many commentators seem to equate austerity with deficit reduction.

As has been argued ad nauseum on this blog and elsewhere for the past four or so years, austerity risks being self defeating even on its own terms. As the government raises taxes and cuts spending, the economy slows. The result can be rising unemployment and hence lower tax revenues and higher social security spending.  In extreme cases austerity can lead to higher not lower deficits.  For evidence of this we only need to look at Greece or Spain where we now a see a familiar cycle of missed deficit targets, even tougher austerity, more missed targets and then even more austerity.

As Keynes argued in a radio talk in 1933:

…you will never balance the Budget through measures which reduce the national income. The Chancellor would simply be chasing his own tail! The only chance of balancing the Budget in the long run is to bring things back to normal, and so avoid the enormous charges arising out of unemployment.

The UK case, given domestic control of monetary policy, a reasonably accommodative central bank and freely floating exchange rate, thankfully isn’t quite as severe. But the evidence still suggests that austerity is proving to be self defeating.

The graph below tries to demonstrate this. It takes the discretionary changes in fiscal policy announced at the June 2010 budget (incorporating the fiscal tightening from the Darling plan) (all available on table 1.1 of the June Budget document). It shows how much the Chancellor is raising taxes and cutting spending, cumulatively, from fiscal year 2009/10 in each year of the original forecast period. Of course these are only the discretionary changes in policy – actual spending may vary as the social security rises for example.

It also shows the latest OBR forecasts (table 4.29 of the latest report) for how much the deficit will have fallen from the 2009/10 peak.

As can be seen in 2010/11the deficit fell by £20bn. What brought this about? Discretionary tax rises were just £3.6bn and discretionary spending cuts came in at £5.2bn? The answer, of course, is that the economy was growing which boosted tax revenues with an increase in rates and reduced social security spending without cuts.

By fiscal year 2015/16 taxes will have risen by £29bn whilst spending will have been cut by £99bn, for a total fiscal tightening of £128bn. The deficit is projected to have fallen by £104.8bn.

The government will have raised taxes and cut spending by more than the deficit has fallen. In other words even the UK, with its own currency and central bank, aggressive austerity can prove self-defeating.

Austerity isn’t the same as deficit reduction, and the choice between reducing the deficit and growth is a false one. Without growth we simply won’t reduce the deficit at all.

One Response to Deficit Reduction vs Growth: A False Choice

  1. The shattering of a mythical consensus? |
    May 29th 2012, 12:27 pm

    […] noting a similar attachment to both deficit reduction and job creation/growth in the Class poll, suggests that people recognise that this is a false choice. Naturally, in a short term demand deficit situation, it is a false choice. Perhaps people […]