Last month, Vox Political wrote to the Chancellor of the Exchequer, a Mr Osborne, politely asking him whether he had any other documentary justifications for his disastrous programme of austerity after the previous principal pillar of his faith – a paper by Harvard economists Reinhart and Rogoff – had been disproved by a student at a rival university.
Today we received a response! A lengthy, well-considered one at that.
What a shame that we found a way to trash it before we reached the end of page one.
But we’re getting ahead of ourselves. Let’s all read the letter together, shall we? It begins:
“Thank you for your letter dated 22 April about the recent publication by Herndon, Ash and Pollin, a critique to the paper ‘Growth in the time of Debt’ by Reinhart and Rogoff.
“You asked for the Treasury’s views on the recent criticism of the paper by Carmen Reinhart and Kenneth Rogoff which concluded that public debt above 90% of GDP could prove a significant drag on economic growth.
“As you will be aware, the Coalition Government inherited the largest deficit in post-war history due to unsustainable increases in Government spending by the previous Government and the effects of the financial crisis [We don’t know that at all. The largest deficit in post-war history is something to which this writer cannot respond – I only know that the national debt at the end of WWII was 250 per cent of GDP, or very nearly four times as much as it is now. Spending by the Labour administration was less than that of the Conservatives until the financial crisis took place, so the writer is effectively admitting that Conservative spending between 1979 and 1997 was even more unsustainable. As for the financial crisis, the Tories would have done the same as Labour at the time, as is borne out by the history books]. In order to address these problems the Coalition Government set a clear and credible consolidation plan to reduce the risks of a costly loss of market confidence in the UK, to restore confidence and underpin sustainable growth.
“As noted by the OECD in their Economy Survey of the United Kingdom February 2013, ‘global developments have shown that the consequences of loosing [sic] market confidence can be [a] sudden and severe and sharp rise in the interest rates [that] would [be] particularly damaging to an economy with the United Kingdom’s level of indebtedness.’ A 1 percentage point increase in government bond yields would add around £8.1 billion to annual debt interest payments by 2017-18.
“Fiscal consolidation also reduces the risk of adverse feedback between weak public finances and a strained financial sector. This feedback can be very damaging, as evidenced by recent events in the euro area. Globally, the UK has one of the largest financial systems relative to the size of its economy, meaning that any loss of investor confidence in the UK’s fiscal position would not only affect the UK, but also the global economy. As the IMF has stated in their United Kingdom – 2011 Article IV Consultation Concluding Statement of the Mission, ‘the UK financial system thus serves as a global public good’. It is the IMF’s view that the UK’s economic and financial sector policies have a systemic impact on the global economy.
“The Government’s approach is supported by a large body of academic and professional literature which finds that there are strong theoretical and empirical grounds for a relationship between high levels of debt and slow growth, including:
“1. Work by staff of the Bank for International Settlements:
“* ‘The Real Effects of Debt’ by Cecchetti et al, 2011 (published as a Bank of International Settlements working paper in September 2011), found that government debt above 85% had a negative impact on growth.
“2. Research by staff of the International Monetary Fund:
“* ‘Public Debt and Growth’, an IMF 2010 working paper prepared by Kumar and Woo, found that an increase in debt ratio of 10& resulted in an annual decrease of 0.2% in per capita GDP growth, with a stronger effect at higher levels of debt. The paper found some evidence of nonlinearity with higher levels of initial debt having a proportionately larger negative effect on subsequent growth. Analysis of the components of growth suggested that the adverse effect largely reflects a slowdown in labour productivity growth mainly due to reduced investment and slower growth of capigal stock.
“* ‘How costly are debt crises’, an IMF 2011 working paper prepared by Furceri and Zdzienicka, finds that debt crises produce significant and long-lasting output losses. This study also provides support to the idea of a threshold for the debt-to-GDP ratio above which output growth starts to decline.
“* The IMF 2013 WEO box 1.2 ‘Public Debt Overhang and Private Sector Performance’, cites studies that have found a threshold beyond which public debt harms growth. It also lists several reasons why a debt overhang can affect economic activity.
“3. Work by staff of the Organisation for Economic Co-operation and Development:
“* ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ Egert, OECD 2012, finds ‘some evidence in favour of a negative nonlinear relationship between debt and growth using a variety of econometric models.
“4. Work by staff of the European Commission:
“* Report on Public Finances in EMU 2012 supports the statement that public debt can trigger economic growth: ‘higher debt levels and interest rates might weigh on economic growth, especially when debt exceeds a certain threshold level as a number of papers suggest.’
“There are also theoretical reasons, highlighted in Boskin, 2012 and OECD, 2012 for believing that higher levels of public debt will damage medium-term growth prospect:
“* First, tax hikes needed to service a higher public debt may crowd out private investment by reducing disposable income and saving.
“* Second, if the higher debt servicing costs associated with increased debt levels are financed by increasing tax revenue, they also imply a deadweight loss on the economy as a result of distortionary effect of raising tax revenues.
“* Third, there is broad agreement that large deficit and debt levels are associated with a higher level of long-term Government bond yields which may crowd out productive public investment and reduce private investment through an increase in the cost of capital. Reduced investment in research and development will have long-lasting negative impacts on growth.
“The approach is also supported by international organisations. The OECD, for example, noted in its November 2012 Economic Outlook that ‘With the budget deficit (excluding temporary factors) at over 8% of GDP and gross government debt at over 80% of GDP, fiscal consolidation is necessary to restore the sustainability of public finances and will strengthen medium-term growth prospects. The fiscal stance remains appropriate, and is supported by the strong institutional framework.’
“Olli Rehn, Vice President of the European Commission, on the speech of the Spring Forecast in May 2013 noted: ‘It is important that the UK follows through with consistent consolidation of public finances with a view to achieve (sic) a more sustainable fiscal position.’
“At the end of this letter you can find the papers referred to above online.”
I shan’t embarrass the letter’s author by naming that person.
The online papers are:
Cecchetti, Bank of International Settlements, 2011. ‘The Real Effects of Debt’ http://www.bis.org/publ/work352.htm
Kumar and Woo. ‘Public Debt and Growth’, IMF 2010 http://www.imf.org/external/pubs/ft/wp/2010/wp10174.pdf
Furceri and Zdzienicka. ‘How Costly are debt crises’, IMF 2011 http://www.imf.org/external/pubs/ft/wp/2011/wp11280.pdf
IMF April 2013 World Economic Outlook (WEO) http://www.imf.org/external/pubs/ft/weo/2013/01/
Egert, OECD 2012. ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ http://www.oecd-ilibrary.org/economics/public-debt-economic-growth-and-nonlinear-effects_5k918xk8d4zn-en
Boskin, M. Stanford Institute for Economic Policy Research, 2012. A Note On the Effects of the Higher National Debt On Economic Growth http://siepr.stanford.edu/publicationsprofile/2491
OECD Economic Outlook, November 2012. http://www.keepeek.com/Digital-Asset-Management/oecd/economics/oecd-economic-outlook-volume-2012-issue-2_eco_outlook-v2012-2-en
European Council, 2012 UK Country Specific Recommendation (CSR). http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/20_scps/2012/04_council/uk_2012-07-10_council_recommendation_en.pdf
… all of which can be picked apart with one observation and a couple of attached questions:
Mr Osborne demanded in 2010, that cuts to welfare benefits alone should total £18bn per year by 2014-15 (meaning a total of £90bn over the five years of Coalition government). Other government departments have had to take huge hits as well.
So why is the total drop in the deficit this year just £300 million? And why is the national debt now more than 88 per cent of total GDP – well inside the danger zone that Mr Osborne has been trying to avoid?
Could it be that, once put into practice, the theories outlined above aren’t actually worth a farthing?
Expect much more on this subject as we really get our teeth into the material the Treasury has kindly provided.
Looking forward to the next episode. Osborne is an embarrassment to himself and government in general. Thanks for a great evenings reading, keep up the great work. Afterthought, “Yes Minister” just sprung to mind!!
Reblogged this on Diary of an SAH Stroke Survivor.
So much for economic forecasting and theories!
Reblogged this on kickingthecat.
No surprise, the country is f***ed!!
labour paid of the last of the war debt thats what he sold gold of 4, this government is ruing our country and if people can see it shame on them 4 listening 2 there lies
Very Good piece of Work Vox looking forward to reading through and Behond
Always interesting, always informative – thanks!
You’re wasting your time, they’re just bullshitters. Where’s all this unspent money going? Folow the money and you’ll find out what’s really going on.
double dutch if u ask me, my motto has always been follow the money, and who do we owe all this money to?????
Most of it is UK savings in UK based institutions buying UK govt bonds – so for the most part it’s like borrowing within the family except safer + there’s interest paid for the duration of the loan. And govts get to build all sorts of infrastructure that will help future generations to earn a living. Had previous generations not borrowed we wouldn’t have sewers, railways, roads, schools, hospitals …and democracy (of a sort) etc etc. Not all bad then.
You’re mistaken about the government building ‘all sorts of infrastructure’ – check out Jonathan Portes’ article at http://www.huffingtonpost.co.uk/jonathan-portes/deficit-is-falling_b_3137277.html?utm_hp_ref=uk-politics
He writes: “Most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half.”
Think you need to read what I said a bit more carefully, Mike.
I was attempting to make the case for public sector investment and that it’s ok to borrow from ourselves to maintain and expand OUR social infrastructure – and by inference it’s not a good idea to cut it.
I just did read what you said again and that’s not how it comes across. It looks like you’re saying governments – including this one – get to invest in large infrastructure projects, so even this government isn’t all bad. See for yourself.
Thanks for the clarification, with which I agree.
The deficit was only 3% of GDP before the markets-know-best deregulation-driven crash ( Gideon was clamouring for even more freedom for banks in 2006); this may not be a Keynesian position in a boom but it was bang on the money for fiscal ok-ness as per the EU stability and growth pact. The deficit began to grow ONLY after the crash to the double figures as % of GDP. that the Coagulation now ascribe to discretionary spending by Brown.
Lies damned lies and politicians with their lips moving.
The thing is, we dont borrow from ourselves-we borrow from the central bank, which charges us for the use of our own money. And PLEASE dont tell me its nationalised because it isnt. Its owned by Rothschild and has been since Pitt the Younger borrowed money to fight Napoleon. We also have to pay (@ 2.2% compound) to use our own income tax funds.
Thanks for showing that this guff proves nothing. The government’s spending plan is an ideological programme to increase the power of the wealthy, couched in language that Osborne himself doesn’t even know how to use properly
Thanks for this – Sterling work!
I think we all knew in our hearts that the economic ‘crisis’ as a justification for austerity was really just a front.
The Tories are self-serving parasites feeding on the poor & weak, always have been and always will be. I suspect they realised form the start that they were unlikely to get back in and so have taken an opportunistic 5 years to trough off the state as much as possible.
I agree with everything you said, but are the other parties also self-serving parasites?
The city of London base for Financial services industry was the driving force behind the British Empire, trade, infrastructure building and er, “slavery”. What we have now, is a mutated form of the British empire, which sold it’s military power to the USA but Britain’s financial services Industry has become top heavy. Britain no longer has an Industrial Revolution to fund or a global empire.
We are now looking at “localism” as a solution, because free market globalism plus the Euro experiment have simply failed.
Life goes on, but the present mechanism for Britain’s Industrial growth is couched in forex , carbon credit and stock trading.
The nation is being run by stock brokers and gamblers on the one hand and career academics, politicians, PR Men, statisticians and economists who get lost in their own spin and spread sheets.
Good work indeed for putting the point to the Exchequers office. But let’s see what we get back.
Austerity is such an obvious way of saving the UK economy I fail to see how anyone with the slightest bit of common sense cannot understand it.
Create mass unemployment, drop tax revenues and hence increase our borrowing from the banks. Use the money borrowed from the banks to pay back to the banks so they can loan it out to businesses that don’t need it as nobody is buying their goods.
Cut welfare and health spending so that we can give the banks more money and make people even poorer so they have less to spend. By making people poorer we stop them spending so avoiding the need for banks to lend to businesses as they don’t need to expand to fill a non existent market.
Then we can lend more to the banks to encourage them even more to lend to businesses that don’t need it. Businesses that don’t need it will leave it in the banks and therefore the banks will be overflowing with money and we have no “banking crisis” and therefore global financial meltdown is avoided.
See !! told you it was easy to understand, and I never even studied economics.
Oh! I see it all now!
How could we all have been so blinkered?
Thanks for explaining it to us in that simple and concise manner.
I think you’ve covered everything. 🙂
Its only a race to the bottom for “us” not “the banks” it would seem….
Emeritus Professor Malcolm Sawyer, from Leeds University, has criticised austerity extensively. He says:-
“The austerity programme is economically irrational, socially irresponsible,
and lacks credibility that it can reduce the budget deficit and secure any return to prosperity.”
Since this guy is very well qualified and experienced in Economics and Mathematics, unlike Gormless George with his pathetic 2nd class degree in History, something tells me his arguments carry more weight.
The articles the treasury have cited seem to me to point towards the negative impacts of debt, however none seem to address the course of action to reduce debt, which is a separate argument. Not broaching the problem of how to reduce debts just the problems with having them and how they adversely impact on growth. Where is the evidence to say the coalitions program to reduce debts, austerity, doesn’t also affect growth? As much as the argument that there is a problem with debt and deficit has been substantiated then does not the decisions the government made to combat this also needs an equivalent substantiation?
Being the supposed political strategic ‘genius’ of Osbourne – ie the political calculation comes first, I read the governments actions as making sense only if we understand that the long term goal is reduced state and possible whilst securing the current privileges enjoyed by some of his peers. In this way whether the country begins to grow again or not it all works towards this goal, privatisation of the remaining public service (at great up-front cost) and major cuts to government spending, including the welfare state in particular, in an austerity drive. If this fails, the finances will be in such a bad state that any incoming government would find it very difficult to reverse the changes made. If the country grows, austerity is proved right and maybe they will even get re elected. Either way they achieve the neo-liberal agenda they want.
I think you’ve hit the nail on the head.
I haven’t had much chance to actually read the material that was referred to me by the Treasury since it arrived – I’ve had a heavy workload this week – but there was something nagging at the back of my mind about the thrust of it all, and you’ve got it in a nutshell: It’s all about WHY something should be done, but not WHAT should be done. There is no material to substantiate the choices Osborne has made.
Add to this the growing body of work that refutes, or at least repudiates, the 90 per cent debt cliff, and I think the only conclusion is that he’s shrinking the state under cover of austerity.
Yes Well That’s always There Aim ! New Laws for Police ,Water Cannon to do what with Hose down Gardens or the Civil unrest They are Creating,???????????????
Just found this written by a Tory MP in the Huffington Post calling the deficit a ‘myth’ and accusing Cameron and Osborne of lying to the public.
Looks like Cameron is on his way out…
You need to look at the dates on articles like this – it was written in late-October last year. Ramesh Patel isn’t a Tory MP but a financier and marketer. His article created a stir at the time – and continues to do so, as your comment illustrates – but ultimately did not affect the Coalition government in any meaningful way.
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The argument over austerity has gone on for the last 3 years. No number of papers, reports, arguments or reasoning are going to change the governments mind.
As we are all aware the Tories have had a hatred for any form of social benefit for the working classes since forever. Education, welfare, NHS, nationalisation, equality, justice, freedom have never been an aspiration of the Tory party, indeed they have fought tooth and nail to prevent any such happening.
Let us not forget the whole social welfare and health service was put in place whilst we were paying back massive war debts. The taxation taken from the wealthy was extremely high and saw a massive decline in the wealth of the ruling class.
This is payback, revenge, spite or whatever other word you want to call it, pure and simple. No economic basis, no “good of the country” basis, no social basis, and most certainly no “global” basis for any of these policies.
The amount of money being spent on the vilification of the lowest in society, some £10 billion, could have created in excess of 200,000 full time jobs which in turn would have had a knock on effect on the economy and tax revenues probably twice that figure.
Instead the government deprives a million of the poorest people of any income and as these are the ones most likely to spend their money locally totally destroy the economy.
I notice in the letter above a lot is made of “theoretical” research and papers. As we all know theory is just that and as soon as it is tried it is then a proven fact. In this case the theories have in fact been proven to be wrong.
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