The Politics of Austerity

A Recent History

Michael Burton

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137482853
• Topic: Politics & International Relations
• Subtopic: Trade & Tariffs
• Index: Politics & International Relations

This book considers the relationship between public spending and public deficit and the varying successes and difficulties governments have had in recent years to balance the two. As the fiscal crash of 2007/8 turned into the Great Recession and tax revenues tumbled, public finances across the UK, the USA and Europe plunged into deficit. Controversial attempts by governments to balance their budgets, commonly described as austerity by critics, had mixed success, politically and economically. Michael Burton outlines how politicians tackled the worst economic downturn in over half a century, drawing on previous examples of deficit-reduction to see how governments managed public finances in recessions and where austerity worked and where it failed. This two-part book, which for the first time provides an historical context to austerity, analyses firstly deficit-reduction in the UK in the 1970s, 1980s, 1990s and 2010-2016, and then looks at case studies in Europe, the USA, Canada and Asia Pacific. The author concludes that with the ageing population placing greater pressure through health and pensions on the public finances of the developed world, politicians and their electorates will have to learn to live long-term with austerity.

© The Author(s) 2016

Michael BurtonThe Politics of Austerity10.1057/978-1-137-48285-3_1

Begin Abstract

1. The Politics of Austerity: A Recent History

Michael Burton¹ 

(1)

London, UK

 

End Abstract

Introduction

After 15 years of recession-free economic growth, enjoyed by both Europeans and North Americans from the mid-1990s, the financial crisis of 2008 was a brutal end to the dream that the days of boom and bust were over. The crash also blew a hole in the public finances of scores of advanced economies, as the apparently endless flow of tax revenues to fund public spending dried up. Governments struggled to respond to the tide of red ink that was engulfing budgets. After initially maintaining or even expanding public spending to offset the sharp drop in private sector activity, governments tried to reduce their debt through fiscal consolidation, cutting spending and increasing taxes, a process dubbed by opponents as ‘austerity’, with widely varying results. For the public, especially the poor, austerity meant hardship brought on by cuts in pay, benefits and public services, higher taxes and declining living standards. How governments manage the politics of austerity, balancing harsh economic realities with voter expectations, form the subject of this book.

The Great Recession that followed the fiscal crash of 2008 was the most severe since the Great Depression of the 1930s. It also lasted longer than its predecessor, with some European countries still struggling to balance their budgets nearly a decade later. Because the Great Recession occurred after 15 years of prosperity built on cheap credit, its impact was particularly felt by a population that had known only plenty and grown used to a generous level of public spending. In some countries, especially those dependent on the taxes generated by financial services or property, the downturn in public finances was catastrophic, causing sudden hikes in budget deficits. Politicians, who had presided over years of spending rises as tax revenues flowed into their coffers, now had to apply the brakes with little understanding of the consequences. In the case of Europe, two ways of boosting recovery, namely exports and exchange rate depreciation, were absent. Because most European countries went into recession simultaneously, it was impossible for them to export their way back to growth by selling to each other, as had occurred in previous downturns while furthermore the eurozone states were locked into a fixed exchange rate through their single currency.

Although this book is ostensibly about an economic subject, namely managing public finances during recessions among developed, democratic countries, my approach is through politics. This has been done because decisions about deficit-reduction are of course taken by politicians. Economists set out theories, but the difficult process of implementing them, including persuading sceptical voters these are in their best long-term interests, is down to governments. In this book, I set out to explore how, why and when politicians make such decisions and drawing on recent examples, try to ascertain a pattern in their response to downturns.

Politicians in Europe and the USA took lessons from the failures of governments in the Great Depression of the 1930s in order to guide them through managing the Great Recession of the late 2000s. Initially, they took the view espoused by the great British economist, John Maynard Keynes, that it was a mistake to cut spending during a downturn. Indeed, governments like those of the UK and the USA poured public money into the financial system to boost liquidity and prevent it from seizing up. Their model from the Depression was not President Hoover, the exponent of cuts, but President Roosevelt, the believer in public works. Once the initial fiscal crisis was over, however, and the crash became a recession, governments in 2009 were left with huge deficits in their public finances that at some stage had to be reduced; the challenge was when. As one prominent UK economist put it: ‘At the height of the crisis spending went up and tax was cut. It was a Keynesian response. The question is at what point you bring the deficit back down and at what speed. That was the balance of risk.’ ¹

The consequent fiscal consolidation programmes, often at different levels of severity and speed in different countries, were conducted amidst fierce debate among politicians and economists as to whether they were either ending or prolonging the recession, whether they were too early in the cycle or whether austerity was necessary at all. Governments that failed to persuade their voters that there was no alternative or could offer no light at the end of the tunnel were punished at the ballot box. The long-dead Keynes, whose theories of full employment supported by public spending had gone out of fashion in the 1970s, was suddenly a household name once again in the corridors of power.

Politicians and economists, who had thought in 2006 that recessions were history, now had to revisit the past for guidance. The Great Depression was not the only example of deficit-reduction. The recessions of the 1970s, 1980s and 1990s all involved periods of fiscal consolidation, some of which were successful in both reducing deficits and boosting economic growth. Indeed, the UK Coalition government in 2010 drew on the lessons of austerity gained from 1990s Canada and Sweden when it embarked on its own programme. The supporters of vigorous deficit-reduction—termed by economists the ‘austerians’—cited the successful examples of Canada, the USA and Sweden in the 1990s, while the ‘anti-austerians’ pointed to the soaring unemployment figures under Margaret Thatcher in early 1980s Britain, using them as a warning of what could happen. In practice, as austerity took effect from 2010, both parties were correct and could produce examples to support their own arguments.

The controversy over austerity economics has often been described as a political battle between left and right, Keynesians and non-Keynesians. Yet Keynes believed in running budget surpluses when economies were expanding. His biographer noted that Keynes’s fiscal policy ‘required current spending to be balanced by tax revenues’, adding: ‘It may surprise readers to learn that Keynes thought that government budgets should normally be in surplus … nor was Keynes a tax and spend fanatic. At the end of his life he wondered whether a government take of more than 25 % of the national income was a good thing.’ ² Some of the most successful deficit-reduction programmes have taken place under left-of centre governments such as the UK in the 1970s, Canada and Sweden in the mid-1990s and the USA under Democrat President Bill Clinton. These programmes occurred in democratic countries whose politicians had to not only apply unpopular measures to balance their budgets, but do so while maintaining the support of voters which, in most cases, they managed successfully.

In the next chapters, I shall examine how governments in the developed, democratic countries initiated previous programmes of fiscal consolidation, or austerity, as well as focus on cases from the recent Great Recession. I have divided the book into two parts. The first looks at the UK which, after a long period of economic growth from 1945, went into sharp decline from the 1960s. The 1970s, whose oil price shock devastated many western economies, tipped the UK into recession and a Labour government found itself initiating the toughest programme of spending cuts since the 1930s. The decade also marked the end of the Keynesian consensus over maintaining high employment and high public spending and led to monetarism and Thatcherism. The recession of 1980/1981, made worse by spending cuts, turned into the boom of the late 1980s and the bust of the early 1990s, when another round of austerity created a budget surplus. There followed the longest period of public spending increases since 1945, until the fiscal crash. The Labour government of Gordon Brown briefly pursued a Keynesian policy of maintaining spending, but the new Conservative-led Coalition in 2010 set out an ambitious five-year programme of fiscal consolidation to reduce the deficit with mixed results; debt remained high, the deficit was still 5 % in 2015, but the UK’s GDP growth was among the fastest among developed nations.

In the second part of the book, I look at case studies from other developed, democratic countries. This is complicated by the fact that some have federal systems, but rather than unpick the fiscal balance between central and provincial, I work on the budgets, including deficits and more rarely surpluses, set by federal governments.

The first country I analyse in this second part is the USA, in particular the successful austerity programme of President Bill Clinton which led to a budget surplus for four years, until it was whittled away by tax cuts under his Republican successor, George W. Bush. Next, I look at how Europe dealt with the Great Recession, with a focus on the eurozone, whose single currency made recovery especially difficult for the southern states of Greece, Portugal and Spain. I also spend some time on Ireland, which initiated one of the toughest fiscal consolidations in Europe and emerged with an expanding economy. The Baltic states of Latvia, Lithuania and Estonia also provide some unusual case studies; their own harsh austerity was followed by strong economic growth and they are often cited as examples of ‘expansionary fiscal consolidation’. Canada and Sweden both provide models of successful deficit-reduction programmes under left-of centre governments in the 1990s, though these did not occur without controversy. I also briefly look at Asia Pacific, where the downturn in China in 2015/2016 had repercussions for the Australian economy, which had been enjoying a quarter century of growth and had avoided the Great Recession. Japan, in contrast, endured 25 years of stagnation with the world’s highest debt. I end with a chapter examining the arguments by ‘austerians’ and ‘anti-austerians’ for and against deficit-reduction policies.

While some of the above examples of austerity are historic, they still have much relevance for the future. Gloomier economists already spoke in 2016 of the next recession, even though many countries had yet to emerge from the last one. In addition, the ageing populations of the advanced economies mean a greater proportion of their public spending will be devoted to pensions and health care and less to universal services. No government wants to repeat the mistakes of the mid 2000s by relying on cheap credit and tax revenues from bubbles in property and financial services to fund otherwise unaffordable levels of public spending. Austerity, in its various guises, may be with us for many years to come. For politicians managing expectations, this is a challenge they will have to surmount if they are to win and maintain power. I hope this book will provide some guidance.

Notes

1. 1.
   Author interview with Paul Johnson, director, the Institute for Fiscal Studies, London (January 2016).
    
2. 2.
   Robert Skidelsky (2010). Keynes. (Penguin p.113 and p.xviii).
    

Part I
Austerity in the UK

© The Author(s) 2016

Michael BurtonThe Politics of Austerity10.1057/978-1-137-48285-3_2

Begin Abstract

2. The Rise of Public Spending

Michael Burton¹

(1)

London, UK

End Abstract

On a wet afternoon in the English seaside resort of Blackpool on September 28, 1976, British Prime Minister Jim Callaghan stood up before delegates at the annual Labour Party conference, and in one of the most celebrated speeches of modern British politics, brought to an end 30 years of economic consensus. He told his party members:The cosy world we were told would go on for ever, where full employment would be guaranteed by a stroke of the Chancellor’s pen, cutting taxes, deficit spending, that cosy world is gone …. We used to think that you could spend your way out of a recession, and increase employment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists, and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step … Like everyone in the Labour movement, I believe in a high level of public expenditure. But I part company with those who believe we can rely indefinitely on foreign borrowing to provide for greater social expenditure. ¹

Callaghan’s speech marked the point at which the post-war consensus on economic policy, namely that the state had a leading role in ensuring full employment and preventing recessions if necessary through deficit financing, usually dubbed Keynesianism as a shorthand, drew to a close. As one historian wrote later: ‘It was a landmark in British political history. For the first time a Labour Prime Minister had publicly abandoned the consensus built on deficit spending and full employment.’ ²

But the decades of post-war consensus and the growth of consumerism in the three decades from 1945 had masked underlying structural weaknesses in the UK economy, which became apparent in the 1960s but then disastrous in the 1970s, triggered by external global shocks, a dramatic downturn and a soaring public sector deficit. The management of troubled public finances in the 1970s would turn out, in hindsight, to be a pivotal period between the end of post-war consensus and the start of a new anti-statist, anti-Keynesian ideology whose consequences would last well into the next century.

The Background to Public Spending

Until as late as the nineteenth century in the UK, there were no state pensions, no state schools, no welfare other than the limited handouts under Poor Relief, no state police and no health service other than that provided by volunteers. There were also few taxes and what little revenue was collected went to cover the costs of foreign wars. Classical economists believed the role of the state was to provide defence, police and basic administration. In 1853, the government spent at 2015 prices the equivalent of £2.8 billion, compared to the actual £730 billion in 2015. ³

The pattern was similar in other industrialised countries like Germany and the USA. In the USA in the 1870s, public spending was around 7 % of GDP and did not exceed 10 % in Germany. In France, it was higher at 12–18 %, leading one prominent French economist to warn in 1888 that a share of 5–6 % was moderate but above 12 % was ‘exorbitant’ and would damage the economy. Overall, average spending in European countries in the 1870s was around 10 % of GDP. ⁴ However, social changes in the UK brought about by industrialisation and the decline of agriculture from the late eighteenth century onwards led to a huge increase in the urban population and demands by the working and middle classes for representation in Parliament. ...

Table of contents

• Cover
• Frontmatter
• 1. The Politics of Austerity: A Recent History
• 1. Austerity in the UK
• 2. Global Experiences of Austerity
• Backmatter