Sunday, October 10, 2010

Driving over a cliff with the British government at the wheel (by Shalom Lappin)

The piece below by Shalom Lappin, guest-posted on normblog, is characteristically clear, acute, hard-hitting, and illuminating. And the significance of the issues he's discussing goes well beyond Britain—as evidenced by the way that Lappin draws effectively on current American debates and brings them to bear on the British situation.

Among other things, Lappin highlights one of the more bizarre aspects of current debates about economic policy on both sides of the Atlantic—namely, that so many participants in in these debates seem to have lost sight of the proper relationship between short-term and long-term considerations in the context of a major recession. In the long term, we all have to learn to live within our means (which is one reason why the post-1980 Republican attitude that "deficits don't matter"—except, of course, for propaganda purposes when Democrats are in power—has been so pernicious). In the short run, however, during a severe economic downturn, when the economy has a lot of unused capacity, unemployment is high and persistent, and there is a danger of a self-propelling downward spiral, governments should be running deficits (except in very special constraining circumstances) to pump demand into the system and help stimulate a recovery.

This basic Keynesian insight was a radical innovation when it was first developed, but in the 70 years or so since the Great Depression of the 1930s it seemed to have become an accepted part of conventional economic wisdom, not only among economists but also among semi-informed pundits, journalists, and politicians. The main exceptions, I would have thought, were complete economic illiterates and doctrinaire cranks with a quasi-theological commitment to various pre-Keynesian economic dogmas. People might still disagree with Keynes and Keynesians about lots of other things. But surely the validity of that central insight was generally accepted.

Apparently not. Polls here in the US, as well as other relevant evidence, make it clear that much of the public still finds this whole notion deeply counter-intuitive. But what is more surprising is that there seems to have been some sort of collective amnesia about this basic insight in broad sectors of allegedly informed opinion, including not only journalists, pundits, and politicians but even some allegedly serious economists. The consequences are unfortunate, and may prove disastrous.

(Back in the spring of 2009, when House Minority Leader John Boehner suggested that the middle of an economic crash was a good time to cut federal spending and start balancing the budget, even the conservative columnist David Brooks tactfully described this idea as "insane." But something along these lines now appears to be the official Republican position, and this lunacy seems to make sense to a large portion of the electorate.)

Lappin's piece is worth reading in full (and it's not that long), but here are some highlights:
On October 20 the government will present the results of its Comprehensive Spending Review to the House of Commons. From its own budget commitments, it intends to implement a set of cuts (between 25 per cent and 40 per cent across all ministries over the next five years) that will lay waste to large sections of the public domain in the UK. Given the scope of this assault on services, the debate over the policy that is motivating the cuts has been remarkably restrained. In fact, most parties to this debate have accepted the government's view that large-scale deficit reduction is urgently required in the short term. [....] Critics of the cuts have stressed the social and civil damage that they will do, but most have left the basic economic reasoning of the government's anti-deficit case intact.

In fact, there are very strong reasons for believing that the government's argument is entirely misconceived in economic terms. Neo-Keynesian economists like Paul Krugman and Bradford DeLong argue persuasively that cutting deficits in a time of sustained economic downturn simply exacerbates the deficit and reinforces the trend towards long term deflation. Osborne claims that if the current high ratio of deficit to GDP is permitted to continue, then Britain's credit rating will suffer at the hands of bond-rating agencies. [....] In response to the American version of this argument Krugman and DeLong observe that long-term US treasury bond prices remain low, with there being no indication that the interest rate will go up in the near future. [....] In fact, the situation is similar in the UK, where the ten-year government bond spread is 2.9 per cent, close to the 2.51 per cent spread for US treasury bonds. These rates contrast sharply with the Greek government bond's ten-year spread of 10.37 per cent, and they are significantly lower than the Spanish bond rate of 4.13 per cent. [....]

Similarly, the claim that heavy government borrowing in times of prolonged economic downturn forces out private investment is without foundation. In such conditions there is no substantial private demand to force out of the financial market. [....]

Oddly, these time-worn truths, learned at great cost from previous depressions and recessions, seem to have disappeared from much of the public discussion surrounding the UK government's impending attack on public services. [....]

Krugman has aptly compared deficit reduction worshippers to 'the priests of some ancient cult, demanding that we engage in human sacrifices to appease the anger of invisible gods'. The current debate over government cuts in the UK seems to pit the hawks, who argue that fiscal responsibility requires that the victim's heart be offered up, against the doves, who plead that, in the name of compassion, we should make do with removing an external appendage. In fact, opponents of the cuts ought to be defending a stimulus plan to prevent the economy from sinking further into stagnation, and quite possibly, into serious recession.

[....] If this is the centre of British politics, then conventional political wisdom has moved very far to the right indeed. [....] The radical folly of the current government's proposals has been compared to that of Thatcher's policies in the 1980s. In fact these proposals are far more drastic, and, if they are implemented, the damage that they do to the social and economic fabric of the country may well be irreparable. [....]
Read the whole thing.

--Jeff Weintraub

P.S. Actually, the Republicans' position, in effect if not always explicitly, is still that deficits don't matter—as long as they're caused by tax cuts and military spending.

==============================
normblog (Norman Geras's weblog)
October 4, 2010
Driving over a Cliff with the British Government at the Wheel
Guest-posted by Shalom Lappin

On October 20 the government will present the results of its Comprehensive Spending Review to the House of Commons. From its own budget commitments, it intends to implement a set of cuts (between 25 per cent and 40 per cent across all ministries over the next five years) that will lay waste to large sections of the public domain in the UK. Given the scope of this assault on services, the debate over the policy that is motivating the cuts has been remarkably restrained. In fact, most parties to this debate have accepted the government's view that large-scale deficit reduction is urgently required in the short term. Disagreement has focused on the size of the required cuts, and which areas should be targeted. As a result, the opponents of the government's plans have generally allowed Cameron and Osborne to define the terms of the discussion. The Tories, in turn, have cast the choice as a contest between the tough love of government-imposed austerity in the interest of eventual recovery, on one hand, and continued ballooning deficits that support unaffordable state benefits, while undermining private sector growth, on the other. Critics of the cuts have stressed the social and civil damage that they will do, but most have left the basic economic reasoning of the government's anti-deficit case intact.

In fact, there are very strong reasons for believing that the government's argument is entirely misconceived in economic terms. Neo-Keynesian economists like Paul Krugman and Bradford DeLong argue persuasively that cutting deficits in a time of sustained economic downturn simply exacerbates the deficit and reinforces the trend towards long term deflation. Osborne claims that if the current high ratio of deficit to GDP is permitted to continue, then Britain's credit rating will suffer at the hands of bond-rating agencies. This will increase the cost of public borrowing, and it will stifle economic growth by pricing private sector borrowing out of the credit market. He and others who advance this view invoke the spectre of Britain following the path of Greece to financial ruin. In response to the American version of this argument Krugman and DeLong observe that long-term US treasury bond prices remain low, with there being no indication that the interest rate will go up in the near future. They attribute this situation to the depressed state of the economy, which causes investors to seek safety in government bonds rather than putting their money in the stock market. In fact, the situation is similar in the UK, where the ten-year government bond spread is 2.9 per cent, close to the 2.51 per cent spread for US treasury bonds. These rates contrast sharply with the Greek government bond's ten-year spread of 10.37 per cent, and they are significantly lower than the Spanish bond rate of 4.13 per cent.

One might insist that the current low interest on UK bonds is the result of the government's announced cuts restoring market confidence in its capacity to handle the public finances. In fact, there is no evidence for this claim. The Obama administration has resisted deficit reduction measures, and it has even recently announced a modest new stimulus programme. Greece's extreme austerity program has not improved its credit rating or attracted foreign investors. A more plausible explanation for the low cost of government bonds in both the US and the UK is continued market fear of recession in the two countries.

Similarly, the claim that heavy government borrowing in times of prolonged economic downturn forces out private investment is without foundation. In such conditions there is no substantial private demand to force out of the financial market. Government investment, financed by deficits, is the major source of demand, and hence a necessary instrument for preventing widespread economic collapse. Deficit reduction is best achieved through economic growth, and significant cuts are best deferred to a period of relative prosperity.

David Cameron's suggestion that we can export our way to high growth while implementing deep budget cuts, as Canada did in the 1990s, is, at best, unrealistic. It ignores the fact that Canada was able to significantly increase its exports to the United States (largely by devaluing its currency) because of the economic boom of the Clinton years. By contrast, Britain's main trading partners in Europe and North America are themselves contending with recession or slow growth, which they are trying to offset by increasing their own exports. It is unclear, then, where the foreign demand for British goods and services will come from when global demand is weak.

Oddly, these time-worn truths, learned at great cost from previous depressions and recessions, seem to have disappeared from much of the public discussion surrounding the UK government's impending attack on public services. The Liberal Democrats, self-styled champions of progressive values, have become eager collaborators in an economic programme that would have done Herbert Hoover proud. Vince Cables' recent false heroics aside, the Liberals in coalition are serving as ticket conductors on the buses that Tory drivers are eagerly racing over the cliff of financial disaster. Ed Miliband, anxious to ingratiate himself with what he takes to be the 'centre' of the British political spectrum, has been steadily backing away from sharp criticism of Osborne's budget, while making obsequious noises about the need for large-scale cuts in the interests of fiscal responsibility. Even the TUC, which took a robust stand against the government's budget at its recent conference, has failed to cogently challenge the economic arguments driving this budget.

Krugman has aptly compared deficit reduction worshippers to 'the priests of some ancient cult, demanding that we engage in human sacrifices to appease the anger of invisible gods'. The current debate over government cuts in the UK seems to pit the hawks, who argue that fiscal responsibility requires that the victim's heart be offered up, against the doves, who plead that, in the name of compassion, we should make do with removing an external appendage. In fact, opponents of the cuts ought to be defending a stimulus plan to prevent the economy from sinking further into stagnation, and quite possibly, into serious recession.

Particularly revealing in all of this is the remarkable cynicism of Cameron's use of the traditional right-wing discourse of 'empowerment' through small government to package his cuts as politically progressive. It is a line that the Liberal Democrats are peddling with an increasingly hoarse desperation, as the economic and social devastation that the cuts portend becomes obvious to their own supporters. If this is the centre of British politics, then conventional political wisdom has moved very far to the right indeed. As services are withdrawn, communities will be empowered to supply them at their own cost. As jobs disappear, one will be free from employment, the income it provides, and the social benefits that used to be available to mitigate poverty. Those with the means to absorb these changes will not be adversely affected. The middle and the working classes and the poor, for their part, will have the satisfaction of knowing that their suffering is serving the national economic interest.

The radical folly of the current government's proposals has been compared to that of Thatcher's policies in the 1980s. In fact these proposals are far more drastic, and, if they are implemented, the damage that they do to the social and economic fabric of the country may well be irreparable. One wonders how much unnecessary hardship will be inflicted upon the population before the sort of widespread dissent that toppled Thatcher from power will emerge as a leading force within the political mainstream.

(Shalom Lappin, King's College London.)

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