Unless the polls are wildly inaccurate, the Conservative party is heading towards a catastrophic defeat in the coming election. All across the rich world, voters are angry at their governments – they blame politicians for a burst of inflation that happened almost everywhere and is now subsiding almost everywhere, including in the UK. But the Conservatives deserve defeat more than most: they took power 14 years ago promising to deliver responsible policies and economic success. Instead they have presided over economic stagnation and a collapse in public services. Why has Conservative governance gone so badly? It is natural to blame Brexit, which did indeed increase trade frictions and therefore surely had a negative effect on British real income. However, Brexit has not had the disastrous effects some predicted, and has somewhat perversely led to a rise rather than a fall in immigration, especially of the highly skilled.
In fact, the roots of Britain’s poor economic performance are older and deeper than Brexit. Though many bad decisions undoubtedly contributed, one central cause was the way David Cameron and George Osborne gratuitously embraced fiscal austerity when they came to power after the global financial crisis. At the time, this looked like an obvious macroeconomic error; more than a decade later, it has become a social and political catastrophe. Let us recall the circumstances when the Conservatives took power. The financial crisis had produced a severe global recession; by 2010 the world economy was growing again, but all major economies, Britain included, were still operating far below capacity and had high unemployment. Textbook economics tells us that when unemployment is high and inflation is low, governments should try to stimulate demand with reduced interest rates and fiscal deficits. Interest cuts were not an option because rates were already close to zero, so the indicated policy was fiscal stimulus. Yet the Cameron government chose to do the opposite, pulling back fiscal support from an economy that still needed it badly. Britain was not the only nation turning to fiscal austerity in the face of high unemployment – Greece engaged in savage austerity, while Portugal, Spain, Italy and Ireland made large cuts, and fiscal policy in the US also turned contractionary. What made the British case unique was that it was almost entirely an unforced error. Southern European austerity was a response to pressure from the bond markets: Greece was in effect cut off from private markets, while other nations faced sharply increased borrowing costs, becoming dependent on official lenders who insisted on budget cuts as a condition for loans. Bond buyers never lost faith in the US, but after 2010 Barack Obama faced a deeply hostile Congress, which in effect blackmailed him into spending cuts by threatening to provoke a government default.
While Britain had low borrowing costs like the US, its government was not divided. The Cameron executive could have chosen to maintain spending. Why did it turn to austerity? Part of the answer is that policymakers were genuinely spooked by the sudden emergence of the crisis in Greece. Until Greece hit the wall, debt crises were generally thought of as a problem that happened only in poorer nations. It is understandable that many observers, at least initially, wondered if the Greek crisis was the leading edge of a broader attack by bond vigilantes. But UK debt was clearly far smaller relative to the economy than Greece’s – and it became obvious early on that contagion from the Greek debt crisis was restricted to eurozone nations. So there was no reason to continue believing that the UK risked “becoming Greece”, as many politicians recklessly claimed at the time. In fact, it soon became clear that even the eurozone crisis was more a matter of market panic than one of fundamentally unsustainable levels of debt. As the economist Paul De Grauwe has said, nations with debts in another country’s currency can suffer something similar to a bank run: panicked investors seeking to pull out their funds can cause a government to run out of cash, forcing it into default. Nations that borrow in their own currency are not vulnerable to such a self-fulfilling crisis, because they can in effect print money in a crunch. This analysis was validated in 2012 when Mario Draghi, the president of the European Central Bank (ECB), said three words: “Whatever it takes.” This was taken to mean that the ECB would, if necessary, supply cash to governments facing a market panic. And suddenly the euro “debt” crisis faded away, with investors demanding much lower interest rates on the debt of Italy, Spain and so on. Since Britain has not adopted the euro and had debts in its own currency, it was not vulnerable to this kind of cash crisis. The bottom line is that there was no pressing economic need to slash spending in the face of high unemployment. I would argue that the best way to explain Britain’s austerity is not economic but sociological. Sociology? I used to talk about the push for austerity being led by Very Serious People (a term I borrowed from the blogger Duncan Black). This was not really a joke: if you spend any time consorting with members of the global policy elite, you realise that many of them are driven primarily by the desire to appear “serious”. In economic terms, this usually means pushing policies that will cause significant hardship – to other people, of course. The obsession with perceived seriousness reflects peer pressure, but in some ways also reflects personal careerism. Officials in democratic nations cannot expect to remain in office for more than a few years. What do they do next? If they have lobbied for “serious” policies, they can have a bright future giving speeches at Davos about the importance of making “tough choices”. Or they might even end up employed by the financial industry to lobby their former colleagues – where a reputation for “seriousness” is a prerequisite, no matter how much damage those policies have caused. (Indeed, Osborne has done both.) Sociology partly explains the Conservative embrace of austerity. But there was also political calculation. Denunciations of debt and deficits often go hand in hand with demands for smaller government, in particular a shrunken welfare state. In effect, politicians whose real goal is to move policy to the right exploit fear of deficits to push an agenda that would be deeply unpopular if stated openly. The Oxford economist Simon Wren-Lewis calls this the “deficit deceit” hypothesis. The deceit aspect is especially obvious in the US, where Republican leaders routinely denounce deficits while pushing for budget-busting tax cuts. But there is every reason to believe that the same kind of cynicism played an important role in UK austerity. It turns out, however, that exploiting debt fears to engineer cuts in public spending tends not to work out quite the way that small-government advocates hope. What serious conservatives – they do exist – want is a less generous social safety net, with fewer income transfers to households, while governments concentrate on those functions that only government can perform. I do not share that desire, but never mind. What is important is that voters do not share that desire: cutting direct financial aid is deeply unpopular. What does this have to do with deficit deceit? Even when a government manages to build support for spending cuts by scaring the public about debt and deficits, it generally finds itself shying away from spending cuts that will directly affect families’ incomes. Instead, it tries to save money by shortchanging public investment and public services, a strategy that seems preferable because the consequences of these spending cuts may not be all that visible in the short run. But the effects of inadequate public investment cumulate over time, so that a fiscal strategy advertised as an exercise in responsibility ends up being deeply irresponsible, leading to crumbling infrastructure and deteriorating public services. This is how Cameron and Osborne’s error has compounded over the past decade. Consider the NHS. I am clearly not an expert on the system, and I am sure that the NHS’s problems have multiple causes. But it is obvious to an outsider that direct public provision of healthcare, while it has major advantages, creates a special form of political vulnerability. Compare the NHS with single-payer systems – including Medicare, which serves older Americans – in which the government pays the bills but does not employ the doctors or operate the hospitals. An attempt to save money by underfunding Medicare would provoke an immediate public outcry – in fact, false rumours of such a move created an outcry in 2010. But a government can underfund the NHS for years before the consequences become obvious to voters, and by that time the crisis can be very hard to fix. To sum up: a decade ago, the main critique of austerity was macroeconomic – it was holding back recovery from the severe recession that followed the global financial crisis. And it did. But that was not the end of the story. Austerity also gradually undermined public services, including healthcare. What will a Labour government do to reverse this damage? There are two reasons to worry it will fall short. First, the era of Conservative austerity coincided with an era of low interest rates and substantial excess capacity, exactly the conditions under which Britain should have been investing in its future. The current environment is much less favourable. Second, Labour’s stated plans lack any ambition to reverse austerity. In the US, the Biden administration came in with bold plans and managed to accomplish a significant fraction of them despite having only a razor-thin congressional majority. I am not hearing anything comparable from Labour, even though Keir Starmer seems on course to have political capital beyond the wildest dreams of US progressives. I hope to be proved wrong. But right now it looks as though the shadow of austerity policies adopted in error 14 years ago will continue to darken Britain’s prospects for many years to come.