Last night on Newsnight Scotland, Gordon Brewer subjected John Swinney and other non-Coalition politicians to some pretty tough questioning on the austerity and the UK recovery. As a presenter and interviewer it is normal to play 'devil's advocate' and challenge the beliefs, suppositions and arguments of interviewees, especially politicians. However, the ferocity of Brewer's onslaught seemed to me to go beyond what is required from an interviewer. Clearly, an interviewer must give due weight to and allow balance between the arguments of opposing sides. But he or she should, in my book, also pay heed to the truth - in this case the theory and evidence on the role of austerity in its effect on the level of GDP and its rate of growth.
Brewer made several assertions. The most important of which were:
1. Economic recovery justifies the austerity policy of the Coalition Government.
2. The scale of the UK output loss meant that other countries would recover faster than UK, so the fact that UK GDP currently remains about -2.5% below its pre-recession peak cannot be used as a criticism of the policy of austerity.
3. The austerity policy was necessary to address the UK's credibility with markets in the face of rising UK Government debt.
4. The OBR believes that "it will eventually become a sustainable recovery."
None of these assertions is unambiguously correct.
The first assertion is simple to dismiss. Economic theory tells us that a fiscal consolidation will lower the level of GDP and the rate of growth. But it will be temporary. Eventually the resources made unemployed by the austerity will move into other uses as market prices adjust, growth will pick up and the level of GDP rise. For non-technical discussions of this see Jonathan Portes, Director of the National Economic Institute for Social and Economic Research (NIESR), and Simon Wren Lewis, of Oxford University. However, some of the loss of GDP and unemployment could be permanent if there are hysteresis effects for which there is a real possibility - see this paper by Larry Summers and Brad Delong. These effects are difficult to model and the OBR makes no allowance for them at all.
So, even with austerity an economy will recover and when it recovers it may exhibit quite strong growth. None of which is to demonstrate that austerity has been a wise policy or "a good thing".
To underline the point that austerity has had a negative effect on the level of GDP in the UK here is the OBR's own graph which shows the effect of the different phases of the UK's fiscal consolidation.
Chart 2.26: Implied impacts of discretionary fiscal policy on the level of GDP
The assertion that the scale of output loss implies that the UK would have had a slower recovery than others is simply wrong. Indeed, you can argue the opposite: a big drop in output should be associated with a big bounce back in growth analogous to the bouncing ball phenomenon: the harder you throw the bigger the bounce.
Bank of England economists, who clearly have no political axe to grind show the UK recovery from the recent recession to be weaker than almost any comparator - see the chart below
Figure 1. Evolution of GDP around recessions (a) and banking crises
Sources: OECD, Reinhart, C.M and Rogoff, K.S (2008), Thomson Reuters Datastream and Bank calculations.
(a) Defined as at least two consecutive quarters of falling output.
(b) Where data are available, covers the G20 advanced economies over the period from 1960 to 2006.
(c) Spain (1977), Norway (1987) Finland (1991), Sweden (1991) and Japan (1992), as defined in Reinhart, C.M and Rogoff, K.S (2008) 'This time is different. Eight centuries of financial folly'.
(d) Zero denotes the pre-recession peak in GDP, or the peak in GDP during the year of the banking crisis, as listed in footnote (c).
As I have said in earlier posts the reason for the UK's weaker recovery is weak UK export performance and fiscal consolidation - see this research from Fulcrum here.
The third assertion, has been well addressed by Paul Krugman in his references to the "confidence fairy". There is just no evidence that a country with its own currency and ability to print money will be at risk of default as debt rises. UK 10-year bond yields were low before the Coalition came to power and have stayed low. They rise when economic growth occurs as the attractiveness of equities increases relative to government bonds. This is happening now. But would the Chancellor say now that this is due to a loss of confidence in his stewardship?
Finally, the OBR did not say in its latest Economic and Fiscal Outlook that " it will eventually become a sustainable recovery." In its view the recovery is being driven by household spending fuelled by falling savings not rising income and housing investment. Real incomes of households need to rise and that will only happen according to the OBR if productivity growth improves. Which begs the question are current UK Government policies towards investment and skill formation appropriate to the task?
All of this is a lot more nuanced and complicated than was allowed to be the case on Newsnight Scotland last night.