As the UK recorded its first current budget surplus in 16 years, the IMF was quick to use this development as sufficient proof to declare the austerity measures, imposed by the UK government in the aftermath of the financial crisis, a success. To the IMF, the UK case of eliminating its budget deficit, while avoiding a prolonged recession, and faring better than other European countries, supports the case for further austerity.
However, this overly simplistic interpretation disregards the long-term structural problems that the UK economy is facing, does not acknowledge the active role played by the Bank of England (BoE) in mitigating the crisis, nor does it attempt to understand what is behind the growing voter discontent that led to the Brexit vote. Furthermore, given that the austerity measures have been linked to 120,000 deaths, it seems rather odd to celebrate this approach.
While at a first glance, one might think the UK economy is in pretty good shape, with low unemployment levels and continuous growth for the last 8 and a half years, a closer look at the data reveals a less optimistic picture. As outlined in this report from the Center for Economic and Policy Research (CEPR) that I co-authored with Mark Weisbrot, the UK economy is facing some serious challenges.
The last decade has failed to deliver any improvement in living standards to most households, with real median incomes of working-age households barely returning to their pre-recession levels this year. Retired household have fared somewhat better, yet are under threat as a target for further spending cuts. While increased employment has meant household incomes reached their precession levels, real hourly wages have not. To make matters worse, a widely cited decline in the gender pay gap is due to a larger drop in male wages, rather than female wages increasing.
One of the most striking and unusual aspects of the recovery is that poverty, by some measures, has actually increased for people of working age. After accounting for housing costs, the percentage of people aged 16–64 with income below the poverty threshold has risen to 21 percent in 2015/16, from 20 percent in 2006/07.
In terms of productivity growth, which is the engine of rising living standards, the past decade has been the worst for the UK since the 18th century. The slowdown in productivity growth means that GDP per person is about 20 percent lower than it would have been if the prior growth trend continued. The problem of slow productivity growth is directly linked to low investment levels in the UK, which has the lowest rate of gross capital formation amongst G7 countries.
The UK currently finds itself in an economy where demand is lagging, and the prospects of Brexit bring significant uncertainty over the future. This is an environment that is unlikely to attract major private investment, especially in the areas it is most needed. There is a clear need for public investment and spending that can grow the economy and improve living standards. More austerity might seem to reduce the government’s deficit now but its price will ultimately be paid through lost output and slower growth.
The negative feedback from the fiscal tightening was undoubtedly mitigated by the expansionary monetary policy conducted by the BoE, which also explains why the UK was able to withstand austerity without deepening its recession and fared better than countries in the eurozone. The BoE started lowering its Bank Rate in October 2008 until it reached 0.5 percent. The rate was further decreased in the aftermath of Brexit to 0.25 percent, only to be raised again to 0.5 percent at the end of 2017.
The most important step taken by the BoE was its Quantitative Easing program, launched in August 2008, to buy bonds and ensure long-term interest rates for the UK remain low. The European Central Bank (ECB) only took similar steps for euro denominated sovereign bonds in July 2012.
While the IMF portrays the UK net public debt-to-GDP ratio as unsustainable high (it was 80.5 percent in 2017), this assessment is mostly arbitrary, especially given the UK’s specific circumstances. The burden on the public debt is best measured by the interest payments on the debt, relative to the size of the economy since the principal is generally simply rolled over. At present, the net interest payments on the debt are about 1.8 percent of GDP, a number significantly lower than in the 1980s when interest payments on the debt were generally above 3 percent of GDP annually, and in the 1990s when they were between 2 and 3 percent per year.
It is essential to note that financial markets recognize there is little risk to holding UK bonds, and the UK government can currently borrow at negative real interest rates. Given that the UK issues bonds in its own currency, investors understand there is no risk of default.
There are many public investments that have a positive real rate of return by increasing the productivity of the economy. Thus, given the current circumstances, it seems rather absurd to focus on reducing the debt rather than growing the economy.
There is no doubt that Brexit is one of the major challenges that the UK faces. However, particularly in this context of uncertainty, macroeconomic policies play an essential role. Unnecessary fiscal and monetary tightening pose an immediate threat to economic progress and the UK’s ability to improve living standards of its residents.
Imposing austerity on an economy where incomes have not recovered from the last recession, there is a large slowdown in productivity growth, an overall lack of investment, and the government can finance its spending at negative real interest rates is senseless and cruel.
For more details, graphs, and complete sources check out the full report.
“While the IMF portrays the UK net public debt-to-GDP ratio as unsustainable high (it was 80.5 percent in 2017), this assessment is mostly arbitrary, especially given the UK’s specific circumstances. The burden on the public debt is best measured by the interest payments on the debt, relative to the size of the economy since the principal is generally simply rolled over. At present, the net interest payments on the debt are about 1.8 percent of GDP, a number significantly lower than in the 1980s when interest payments on the debt were generally above 3 percent of GDP annually, and in the 1990s when they were between 2 and 3 percent per year.”
You do know that the national government deficit = the private sector surplus?
The British government is a monetary currency sovereign, the legal issuer of the GBP. The currency sovereign has a relationship with its unit of account similar to a football referee and the points he awards on the scoreboard of a game when a team scores a goal. Money is keyboarded into existence when the government pays for real goods and services from the private sector and is deleted again when it receives tax payments.
The government is required by law to issue a government bond to MATCH its deficit spending. Note I write MATCH as the money for the bond is already in the economy and moves into the bond for the term of its maturity. This is a low yield risk-free investment. A term deposit with the issuer of the currency which can always pay. The government spending still comes in addition to the bond money and in no way does the bond fund the spending, net assets in the private sector rise overall from the government deficit spending. This is a procedure left over from the days of the gold standard and still goes on.
The procedure could be swapped for a twenty-one gun salute and be just as effective and a lot less damaging to the economy.
Your article comes very close to saying that bonds pay for spending and that government borrowing is necessary, these are cruel neoliberal myths.
Hi Alan, I am not saying that bonds pay for spending. The observation made is about how even in way the current system operates, the only actual “debt burden” is the interest paid by the government, and even under this system the actual debt is meaningless since bonds are usually rolled over. Acknowledging interest payments on bonds are real does not get into the question of whether the bonds are even needed or not. It is rather an analysis of what the current mechanism is – and for most part, except for the bonds held by the BoE (and yes that is actually an illustration of how the government does not need to actually “borrow”), the rest pay interest to those that hold them, and are sold in financial markets, where they need to find buyers.
The following paragraph actually makes the point of the sovereign currency in the context of how bonds are issued: “Given that the UK issues bonds in its own currency, investors understand there is no risk of default.”
I am aware that the procedure could be replaced by anything but that is beyond the point I am trying to make. The idea is that even given how the system works, there is no actual debt burden. So, even if you believe there is no problem with this procedure, cutting spending makes no sense in the current economic context.
The idea for the post, and the report, is to illustrate to those who think spending cuts are necessary that they are not. Challenging their entire paradigm is a whole other issue.