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UK Productivity In The Next Parliament

UK Productivity In The Next Parliament

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I've never seen a panel of journalists and academics spewing so much vitriol at the government as I saw in Oxford on Thursday.

Paul Krugman of The New York Times, Martin Wolf of The Financial Times and David Hendry of Oxford University roundly blasted UK government fiscal austerity during the Coalition, decried flatlining productivity, and called for major public investment, the very opposite of what the Tories promised in their manifesto. 

The event was not a debate so much as it was a tsunami of ire at a UK government whose austerity policies led to the slowest economic recovery for 300 years — a recovery which was only secured when the austerity was paused. Hendry summed up the mood of the day saying "we seem to be governed by the stupidest people I have seen in my lifetime".

I beg to differ. It has become increasingly clear in the last five years that austerity is not about achieving economic growth. As David Cameron put it in November 2013: "austerity should last forever", and Britain should get used to having a "permanently" smaller state. This is about attaining ideological imperatives, not economic growth per se

Of course, economic growth was necessary to continue the program. The pausing of austerity in 2013, which allowed the recovery — and the Tory election campaign — to begin in earnest, illustrates that Cameron and Osborne are pursuing their ideological goals of a leaner state in a wily and circumspect manner. Perhaps they did believe the stuff about austerity boosting business confidence and thus investment at the beginning, but it surely became clear during the Coalition that this was at best a very minor second order effect that did not even begin to come close to offsetting the contractionary first order effect of the cuts to government spending and investment. So, pragmatically, they changed course. And — against a weak Labour opposition who totally failed to hold the Tories accountable for the slowest recovery for 300 years — that was enough to win the election.

This time round, bigger cuts are planned. As I have argued before — and as Martin Wolf seemed to suggest on Thursday — I very much doubt they are actually going to go through with that much contraction. The brunt of the cuts, I tend to believe, will be offset by tax cuts or new spending. After all, they can no longer blame a new recession on the last Labour government.

Indeed, in a nod to his critics, George Osborne is readying a new budget with a so-called "laser-like focus" on raising that flatlining productivity, as well as living standards which have fallen.

This would seem to be rather contradictory for a government planning much more austerity. Raising productivity by slashing investment is like trying to raise muscle growth by slashing protein intake. In the simplest terms, it doesn't work like that.

And this isn't just Keynesian university professors like Krugman and nerdy econ bloggers like myself talking about the importance of investment in raising British productivity. It's the Bank of England. As I argued in April: "The Bank of England points to "reduced investment in both physical and intangible capital, such as innovation, and impaired resource allocation from low to high productive uses" as a cause" for lowered UK productivity. UK investment as a percentage of GDP remains at a pathetic 15 percent of GDP, the weakest in the G7 and as I noted in April "behind Belgium, Gambia, Jordan, Equatorial Guinea and Costa Rica, and barely ahead of Greece!"

The clincher, I think, is the deficit. With real interest rates, inflation, and government borrowing costs as a percentage of GDP near record lows, I couldn't give a flying teapot about the public deficit at this point. As a sovereign currency issuer that controls its own currency and borrows in its own currency, the British government has about as much chance of "becoming Greece" and "running out of money" as I have of shapeshifting into a reptilian. But the Tories — mostly for ideological rather than pragmatic reasons — care about it greatly. And since they paused the austerity, the deficit has begun falling significantly as a percentage of GDP after stalling for a couple of years. In a great twist of irony, the pause in austerity allowed them to look like better deficit-cutters than the austerity itself did!

Cameron and Osborne face a choice: accept the reality that contraction is likely to once again be contractionary, or slash away at the budget risk a new recession, continued flatlining productivity, and falling living standards. As the party who campaigned on a platform of "keeping the economy strong", they would be utterly foolish to not choose the route of investment and tax cuts. And they are not the fools that some of us think they are.

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