GEORGE Osborne yesterday presented his analysis of why the UK economy has turned the corner in recent months, arguing this demonstrated advocates of a “Plan B” had been proved wrong by events.
He identified two candidate explanations for the slowdown of 2011-12. One school of thought he called the “fiscalist” analysis. According to this view, the UK economy plateaued in 2011-12 because the government’s austerity programme had damaged growth. This was the view of those economists, commentators and politicians that advocated the government switch to a “Plan B” of cancelling spending cuts and raising spending in some areas.
The other school of thought he termed the “financial conditions” view. According to this idea, the 2011-12 slowdown occurred mainly because financial conditions were much worse than expected – partly because the damage to the financial sector was worse, but mainly because the Eurozone crisis meant there was the possibility of a widespread meltdown of the European banking system. Into the “financial conditions” view he added the impact of commodity price rises (raising inflation, though he did not use the word). This was the view of those economists, commentators and politicians that supported “Plan A” (or, he might have added, urged more rapid spending cuts).
Osborne said that the financial conditions view had a straightforward explanation for why the economy had picked up in recent months – namely the easing of financial conditions as the Eurozone crisis abated after the European Central Bank’s announcement of the “Draghi Plan” in late 2012. By contrast, the fiscalist view could not explain what had changed. The UK had proceeded with the chancellor’s planned spending cuts and tax rises, and indeed these have accelerated in recent months. So if the 2011-12 slowdown was the result of domestic not international factors, what were the domestic factors that explained the acceleration of 2013?
That seems a fair case, provided it is not taken too far. A number of Plan B advocates first claimed that Osborne’s plan would cause a huge slump, then switched to claiming it would trap the UK economy in a lost decade of Japanese-style flatlining. They contended that the 2011-12 growth slowdown proved that they were right and urged that Osborne switch tracks before it was too late.
But the 2011-12 slowdown was not overwhelmingly the result of government austerity. History will record that the UK economy slowed in 2011 as the Eurozone crisis bit and commodity price rises drove up inflation to 5 per cent (with perhaps a passing mention of North Sea oil output dropping). Once these negative factors faded away, the internal impetus of the UK economy drove it forward in 2013. The economy did not need Osborne to massively increase capital spending or introduce a temporary tax cut or any of the other “stimulus” plans proposed.
This will not end economic debates about the impact of austerity programmes, however. It has been known since the time of the economist David Ricardo in the early nineteenth century that cutting government deficits does not necessarily mean slower growth. But that has not stopped opponents of austerity from spending the past 200 years always claiming it does. Cutting the deficit in the early 1980s or early 1990s did not mean slower growth either, but even that more recent experience did not end the debate.
The smarter sort of anti-austerian might reasonably claim that the events of 2011 to 2013 have little to say about the impact of austerity either way, since Osborne in fact gave up on austerity in late 2011 in the Autumn Statement, when he abandoned his original plan to eliminate the UK’s structural deficit over a Parliament. After that, the budget deficit has been £120bn every year and is scheduled to be that again this year – no deficit reduction at all. Absent any material austerity, it was rather daft to say the 2011-12 slowdown was because of austerity, and daft to claim the 2013 acceleration is because of it, either.
That said, Osborne can nonetheless fairly claim he stuck to his plan, in the sense of sticking to the spending cuts and tax rises scheduled in 2010, even though he did not stick to his deficit reduction targets. Most of the pressure on him was to spend more. He resisted that pressure – and should be credited for that. Over the next 18 months, as growth accelerates, he will take a well-earned political dividend for the vindication of his approach. Down the line, rising inflation may take the gloss off his achievements. But for now, Osborne is entitled to claim his laurels.
Andrew Lilico is chairman of Europe Economics, fellow at the Institute of Economic Affairs (IEA), and contributor to Will Flat-lining Become Normal?, released by the IEA today.