Sir Nicholas Macpherson, Permanent Secretary to H M Treasury, reviews Mr Osborne's Economic Experiment - Austerity 1945-51 and 2010- by William Keegan.
Anybody with only the vaguest interest in economic policy and politics is likely to have come across the works of William Keegan. I started reading his column in The Observer in the late 1970s, when along with Alan Watkins and Adam Raphael he made that newspaper worth buying. And I still read his column to this day. When some years ago another round of Guardian Media Trust cuts led to Keegan’s weekly column becoming fortnightly, I wrote to the editor to remonstrate. Sadly, it had no effect.
I first met William Keegan on the international economic diplomacy circuit – interminable, largely predictable, meetings beginning with the prefix “G” invariably in prosaic venues in exotic locations. It may have been at the Naples G7 summit of 1994 or the annual IMF meetings in Madrid in 1995.
Keynesian through and through
He is an engaging and lucid interlocutor. And, unlike many commentators whose views change with the prevailing orthodoxy, Keegan has always been remarkably consistent. He is a Keynesian through and through. Some Keynesians changed their positions as macroeconomic demand management became less effective. For example, I know one of the country’s most eminent economists now regrets being one of the 364 signatories of the letter protesting against the deflationary Budget of 1981. But Keegan has always tended to the view that there is no macroeconomic problem too big which cannot be solved by changing the balance between the levels of taxation and public spending.
This is a perfectly respectable point of view. Sir Edward (later) Lord Bridges when he was Permanent Secretary at the Treasury could state: “The [Annual] Budget is second to none in importance, since by its influence on the flow of income it can be used both to sustain a high level of employment and keep total demand within the limits of total supply”.
But that was in 1950: appropriately during the period covered in the first part of Keegan’s book – the austerity of the post war years. The author was growing up in Wimbledon at that time, and the thinking of that era has left an indelible mark on him. He rightly celebrates the era of Dalton, Cripps and Bridges, arguing that post war era was a “time of hope”.
Austerity in the 21st Century
The rest of the book covers what he terms “austerity in the 21st century”: the period from 2010 to the present day. Here, Keegan’s argument is as follows: the global financial crisis was caused by excessively light regulation of the banks rather than profligate government deficits; loosening monetary policy can only take you so far when interest rates get towards zero; and therefore a more expansionary fiscal policy was necessary from 2010 to support economic recovery. He goes on to argue that the stronger income growth that would have engendered would have encouraged investment and exports, improving the trade deficit and rebalancing the British economy in the process.
Needless to say, Keegan concludes that the Chancellor and the Treasury are to blame for not following his policy prescription: “The arrival of George Osborne in office appeared to coincide within the Treasury with a revival of the “Treasury view” of the 1930s, against which John Maynard Keynes had railed for years…Alas, the Treasury seemed to forget its interest in demand management”. The Bank of England also comes in for a fair amount of criticism though Keegan can’t quite make up his mind about Dr Carney, noting that he “appear[s] to conform to Napoleon’s requirement that generals should be lucky”.
Some of Keegan’s analysis resonates. The 2008 crisis was a banking crisis pure and simple. Excessive risk had built up in the system; the regulators failed to appreciate the scale of that risk or to address it. As he puts it, it was “a failure of the Group of Seven economic policymaking Establishment”, myself included. Inevitably, countries with bigger banking sectors, notably the UK, were worse affected.
But in one sense it doesn’t matter what caused public borrowing to blow out in 2008-09. Given that the financial service industry was not going to return to its previous size and shape, the Government had to face up to the increasing mismatch between tax and spending. You cannot run a deficit of 10 per cent of GDP for any length of time in a world where there is little or no inflation. Alistair Darling recognised this in 2009-10. And George Osborne, David Laws and Danny Alexander chose to take fiscal tightening further in the summer of 2010.
Keegan is right to point out that the UK is not Greece. It has much stronger institutions and – most important of all – a floating exchange rate. But the longer a Government runs a large deficit, the greater the risk that it hits an inflection point where the markets take fright, and the cost of funding rises sharply: in this respect the Eurozone experience is relevant. The problem for policy makers is that ex ante it is difficult to know where the inflection point is, and that strengthens the case for erring on the side of caution. That’s why the last Government set a debt rule of 40 per cent of GDP and the current one is seeking to get debt on a downward path.
Moreover, the experience of the 1960s and 1970s demonstrated fiscal fine tuning is notoriously difficult to pull off. Infrastructure projects are rarely “shovel ready”. Increases in current spending are even more difficult to switch on and off. And although some taxes can be changed through the flick of the “regulator” switch, the vast majority have a longer lead time.
That is not to say, the Treasury denies a role for fiscal policy.
Successive Governments have acknowledged a role for the “automatic stabilisers” - those tax receipts and areas of expenditure, primarily social security, which tend to vary with the economic cycle. The current Chancellor has told the Treasury Committee: “by not chasing the debt target we have allowed the automatic stabilisers to operate and that is a sensible economic decision, in my view. That supports the economy in that sense, during a cyclical downturn.” And inevitably as interest rates get closer to zero, and so called quantitative easing comes into play, fiscal and monetary policy become increasingly interlinked.
In my view, Keegan underestimates the contribution of the Eurozone crisis and the rise in commodity prices in the slowdown in the British economy in 2011-12 and overestimates the role of fiscal policy. And where I really part company with him is in the view that inflating demand would help the economy to “rebalance”. Unlike the USA, the UK has a very open economy. The experience of the 1960s and 1970s was that higher demand led to higher imports and an even worse balance of the trade. It is not the Treasury’s job to support the Bavarian car industry.
I also can’t help thinking that Keegan finds the recovery of the British economy now sustained over eight quarters an inconvenient truth.
All that said, if you like well written polemics, you should buy Keegan’s book. It is short and to the point, and it makes an excellent sequel to his earlier volume “Saving the world?” Gordon Brown reconsidered, also published by Searching Finance.