The austerity myth: Why the government is counting on unrealistic growth

REGULAR readers of this column will be familiar with the theme of a paper I’ve just published. Called In Search of Austerity, and published by the Mercatus Center, part of George Mason University in the US, it probes the idea that there is far less austerity going on than people think.

It’s a controversial topic. Some argue that austerity caused the double dip recession. Others say that austerity isn’t even happening. A look at recent Budgets helps.

Firstly, we should consider total managed expenditure (TME), which shows government department expenditure limits. This data demonstrates that a majority of departments are actually seeing nominal spending increases. In the two years from 2012, the average rise across all departments will be 7.7 per cent. In total, 13 departments will receive an increase, ten a decrease, and four will see no change. This doesn’t mean cuts are a myth – on the contrary. Some departments are being cut heavily (like local government). But changes in the distribution of government spending should not be confused with changes in the total amount. Indeed, it’s inevitable that larger cuts will be made to smaller departments, given that one of the biggest spending programmes (the NHS) has been ringfenced. An increasing debt burden also means increasing interest payments.

Secondly, TME is forecast to fall, but not in absolute cash terms. Commentators typically look at TME as a percentage of GDP. Indeed, the government expects that the spending ratio will fall between now and 2015. But this ratio can fall for one of two reasons – either because spending is falling, or because GDP is rising.

The government’s figures come from the Office for Budget Responsibility (OBR), but the Treasury also publishes forecasts from several private firms. According to these statistics, the OBR consistently overestimates GDP growth. Indeed its most recent figure is twice as high as the median of the independent forecasters. I wondered what the spending to GDP ratio would be if GDP were to grow at half the rate the OBR forecasts. As the chart shows, it would mean the spending ratio rises.

It is interesting that people are criticising the government for harsh spending cuts. In reality, it’s really just guilty of believing in over-optimistic growth projections. It is always dangerous to trust the forecasts of economists and, when the OBR updates its figures, this ruse will be exposed. The problem isn’t austerity, it’s a lack of growth.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School. www.anthonyjevans.com. Twitter: @anthonyjevans