Posted on Thursday 15 November 2012 by Ulster Business

Austerity Unions

The Age of Austerity has been an economic reality for over three years, beginning with Alistair Darling's 2009 budget and receiving a sonic boost with the formation of the coalition government in 2010.

This mass consensus has remained unchallenged at the top, among world leaders and international organisations until a few weeks ago.

In late October, in their World Economic Outlook, the International Monetary Fund (IMF) made the frank admission that since the beginning of the financial crisis, they have significantly underestimated the damage that could be done to an economy through fiscal consolidation.

Although many reputable news organisations missed this announcement, most picked it up in the following days as the significance of the admission became clear. The IMF is now telling us that the quantitative evidence behind the theory of austerity is significantly flawed and that this has serious implications for policymakers around the world.

In many ways the term austerity is too generous to attribute to current UK fiscal policy. Austerity implies responsibility, prudence and caution, and who could argue against that. Of course what the policy really boils down to is a belief that rapidly adjusting the government balance sheet and capping national debt is a necessary and sufficient condition for future growth and prosperity. This policy is both naively simplistic and quite fundamentally flawed.

The policy contradicts a central tenet of economic principle, the need for sectoral balance in the economy. Martin Wolf, the Financial Times Chief Economics Commentator regularly alludes to this. Basically put it states that the deficits or surplus of one sector must be met by surpluses or deficits in the other sectors of the economy – all sectoral balances eventually cancelling out to zero. In the UK over the last number of years we had a private sector that borrowed and over leveraged itself culminating in the financial crash. Now, what survived of that private sector is hoarding cash and savings to return to financial health. If the private sector is to increase savings this must be met by investment (non-saving) in other sectors of the economy. This need cannot be met by households who, like the private sector, took on huge debts particularly in housing and mortgages. Nor can it be met entirely by increased trade, particularly given the recent increase in the UK's trade deficit. This only leaves the government sector.

Many would argue that the private sector on its own should borrow to expand and pay back debt from increased profits. This proposition suffers from two flaws. Firstly the private sector is made up of a myriad of different firms and industries that don't have an agreed opinion on anything, let alone the capacity for coordinated action. Secondly financial institutions are extremely unwilling to lend in the private sector – they may not be able to run deficits even if they wanted to. But financial institutions are willing to lend to the government sector as evidenced by record low UK government bond yields. Outside of the Eurozone nearly all western governments can borrow at comparatively low rates. The government sector is large enough and integrated enough to take action to shift the economy out of a downward spiral. The banks expect governments to borrow for investment in the economy, which will allow the private sector to deleverage. At that point the banks will lend again to the private sector which will allow the government sector to recoup its investment.

The case for government action to stimulate the economy exists theoretically, and as evidenced by the IMF research mentioned earlier, the quantitative evidence is there to back it up. Translating the theory into policy is the challenge for today.

The argument does not follow that the government should simply beef-up current spending and that this will in turn create growth and prosperity. Government spending should focus on investment and areas of structural weakness in the economy. Many have identified the lack of housing as a key weakness for the UK, and that of course has regional variations. Here in Northern Ireland we have a clear lack of social housing. Investing in infrastructure is also not limited to creating new infrastructure, it is equally about making existing infrastructure more efficient. In Northern Ireland we have a heavy reliance on imported fossil fuels and making homes and businesses more energy efficient through a retro-fitting scheme is an essential investment for the future.

Home building and retro-fitting are highlighted because the construction sector has been the most impaired sector in the economy since the crash, and also because construction sector activity has the greatest multiplier for the rest of the economy. Research for the Construction Industry Federation found that every £1m of output created up to 28 jobs directly and indirectly. Other estimates of this multiplier range from 23 to 32.

The UK government has made some attempts to address these issues in the light of the poor performance of the economy since they took office. They have proposed government guarantees for investment projects and endless rounds of quantitative easing to free up capital, with questionable success.

The UK government need to recognise that balanced budgets and decreasing national debt, while desirable in the long term, will not of themselves create jobs or growth and, as a strategy, is doing more damage to the economy then they thought. There is logic to increasing borrowing in the short term with a credible plan to return to fiscal balance in the longer term. There is a sensible alternative to austerity for any government who wish to choose it.

Paul MacFlynn is an economist with the Nevin Economic Research Institute, based in Belfast. www.nerinstitute.net

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