The cabinet reshuffle which British prime minister David Cameron delivered after his unexpectedly decisive election victory has only increased the standing of his next door neighbour in Downing Street. Chancellor George Osborne’s management of the economy has seen his stock rise – and not just through the ubiquity of the “long-term economic plan” campaign mantra. He has successfully sold an austerity narrative to key parts of the electorate, but there is more to the chancellor’s idea of austerity than first meets the eye.
When Osborne moved in to Downing Street, the official expectation was that the deficit for the fiscal year just ended would be 11.8% of GDP. Nothing like this had ever been experienced in British history in peacetime. The borrowing requirement was clearly unsustainable.
Keynesian doctrine pointed to the “automatic stabilising” function of the government budget. The theory goes that the economy would be boosted by the excess of government spending over taxation. As output recovered, so would tax receipts and the deficit would disappear. Economic growth (or inflation) would then increase our capacity to pay the interest costs of the extra borrowing.
But an immediate problem was whether financial markets believed that recovery would be prompt enough to prevent borrowing from getting out of hand – in other words when the interest payable on borrowing rises beyond what can be extracted in taxes. This seems to be what drove the chancellor’s rhetoric about the central importance of reducing the deficit. He needed to demonstrate he had a deficit-reduction plan to keep financial markets calm. Otherwise interest rates on government borrowing would go up, creating more budgetary problems.
But at the same time the depressed economy required a substantial fiscal helping hand beyond that provided by automatic stabilisation. Thanks to the Office for Budget Responsibility that Osborne established at the same time, we can compare his actions to his words.
According to calculations using OBR data, the cumulative effect of his fiscal policy changes from 2010 to 2015 has been to add £162 billion to national debt (more than £2,500 per head of population). Most of this has been driven by the chancellor’s expansionary budget of June 2010, perhaps surprising in view of the central billing of deficit reduction.
But even taking this budget out of the calculation, Osborne’s measures have still increased the national debt by £8.5 billion. Adding up the consequences of the fiscal policy changes of every budget since 2010 shows that these initiatives have increased net borrowing in each year, apparently not altogether consistent with “austerity”.
In view of the chancellor’s rhetoric, it might be expected that such extra borrowing had been induced by tax cutting, rather than by enhancing spending. But this is not so. By fiscal year 2014-15, in fact, Osborne’s budgets have raised nominal spending by £16 billion, excluding the uplift from his first 2010 budget. Including this first budget, the expansion is more than £90 billion (about £1,500 per person in the UK).
Taking into account the size of GDP or of tax receipts, is this extra borrowing very much? GDP for the most recent financial year is around £1,700 billion and tax receipts about two-fifths of that. As GDP goes up so does tax-paying and debt servicing capacity (so it is reasonable to hope).
Unfortunately, the recession has proved far longer than any other in British history and, in addition, tax receipts have been lower than expected in relation to GDP. That means Osborne has been obliged to trim his sails to the wind, although this has not often been noticed.
Whereas in November 2010 projections were to reduce borrowing by 2015-16 to 1% of GDP or £18 billion, in fact we have a 4% or £75 billion deficit expected for 2015-16. So, on one hand we are borrowing too much still. On the other, any less borrowing would have squeezed demand further and delayed the recovery that now seems to be underway.
What does this augur for the future? On one interpretation of his track record, Osborne has not succumbed to an ideological pursuit of austerity. He has instead been a pragmatic chancellor, even though he could not admit to it during the election campaign.
If this is correct we may hope to expect more pragmatism in fiscal policy over the next few years, rather than allowing a Conservative majority government to spark a determination to reduce the share of government spending and the size of the public sector, regardless of the costs.