15 July 2021

Austerity: When is it a mistake and when is it necessary?

John Fender
2020, Agenda Publishing, 135 pages,
ISBN 9781911116936

Reviewer: William Allen, NIESR

‘Austerity’ has become a term of political abuse. It is held responsible for every failure of public services. It is therefore very welcome that John Fender has written a clear and carefully-reasoned account of what austerity means, and in what circumstances it can do good or harm.

Long ago, the term ‘austerity’ was applied to the fiscal policy of the post-war Labour government, which achieved budget surpluses averaging a remarkable 4.3% of GDP over the three fiscal years 1948/49 – 1950/51. More recently, it has been applied with as much or more venom to the fiscal policies of the coalition government of 2010 – 2015 and the Conservative governments of 2015 – 2019, during which decade there were budget deficits averaging 5.0% of GDP.

Why the venom? The budget went into heavy deficit following the financial crisis of 2008, partly because of the cost of bailing out the banks, but much more because of the recession that followed the crisis. Bailing out the banks was deeply unpopular, but the ratio of government spending to GDP in 2019/20, just before the coronavirus pandemic, was 39.8%, exactly the same as in 2006/07, just before the financial crisis. So the effects of austerity on public spending don’t appear, on the surface, to have been very terrible.

However, the distribution of public spending has changed. Between 2006 and 2019 there were big increases in spending on health (+ 1.2% of GDP, even before coronavirus), economic affairs (+ 0.7%) and social protection (+ 0.6%). There were compensating relative reductions, notably in education (- 0.8% of GDP) and general public order and safety (- 0.5%). As the population ages, and as scientists discover new ways of treating diseases, demands for spending on health and social care are certain to rise further relative to GDP.

Animosity towards austerity has several roots. First, the sense that it’s all the fault of the banks, and of the government for bailing them out. Bank bailouts are part of the story, but a modest-sized part. Second, the priority that the public attaches to free-of-charge health care. Third, concern that public services generally are not working properly because they are under-funded.

As Fender wisely remarks, ‘it would be better if governments pursued policies which meant that austerity rarely needs to be implemented.’ But that is difficult. Increasing taxes reduces incentives and impairs output and economic growth (there is, in my opinion, currently a strong case for a temporary post-coronavirus tax, but it has no political support). Cutting spending, or finding other ways of financing services, provokes public resistance. Fender rightly points out that it is not possible to finance spending without limit by more and more borrowing.

It is the job of the Treasury to manage the problem and keep the public finances stable. Since 2010, it has been supported in this task by the Office for Budget Responsibility, which produces detached and high-quality analyses of the public finances. The Treasury’s job has gradually become more difficult. A hundred years ago, there was no question of running a deficit to support the economy during the influenza pandemic. Nothing was allowed to get in the way of balancing the budget, notwithstanding the huge increase in debt interest costs which had arisen from the First World War. Since then, the state has increasingly acted as insurer of last resort, and it has done so on an enormous scale in the coronavirus pandemic. As an insurer, it needs to be sure that it has ample financial resources; hence the need to take advantage of good times to reduce debt ratios, as Fender sensibly suggests.

Economic growth has the power to wash away debt problems by making it easier to raise the taxes needed to service the debt. It is impossible to know whether a new era of economic growth is at hand. If it is not, it is hard to see how the fiscal problems of today can be solved without a large financial upheaval: a sharp, unplanned tightening of fiscal policy; inflation (though as the Office of Budget Responsibility have pointed out, that wouldn’t help much); or financial repression.

‘Austerity’ is a concise, thoughtful, and temperate guide to these issues. It provides a valuable counterpoint to the avalanche of policy proposals which call for more public spending and imply rising debt ratios. I warmly recommend it.