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The warnings Cameron and Osborne ignored – Paul Krugman 21/10/10

Posted on 27 January 2011 | 9:01am

An article by award winning economist Paul Krugman in the New York Times.

British Fashion Victims

Published: October 21, 2010
In the spring of 2010, fiscal austerity became fashionable. I use the term advisedly: the sudden consensus among Very Serious People that everyone must balance budgets now now now wasn’t based on any kind of careful analysis. It was more like a fad, something everyone professed to believe because that was what the in-crowd was saying.

And it’s a fad that has been fading lately, as evidence has accumulated that the lessons of the past remain relevant, that trying to balance budgets in the face of high unemployment and falling inflation is still a really bad idea. Most notably, the confidence fairy has been exposed as a myth. There have been widespread claims that deficit-cutting actually reduces unemployment because it reassures consumers and businesses; but multiple studies of historical record, including one by the International Monetary Fund, have shown that this claim has no basis in reality.

No widespread fad ever passes, however, without leaving some fashion victims in its wake. In this case, the victims are the people of Britain, who have the misfortune to be ruled by a government that took office at the height of the austerity fad and won’t admit that it was wrong.

Britain, like America, is suffering from the aftermath of a housing and debt bubble. Its problems are compounded by London’s role as an international financial center: Britain came to rely too much on profits from wheeling and dealing to drive its economy — and on financial-industry tax payments to pay for government programs.

Over-reliance on the financial industry largely explains why Britain, which came into the crisis with relatively low public debt, has seen its budget deficit soar to 11 percent of G.D.P. — slightly worse than the U.S. deficit. And there’s no question that Britain will eventually need to balance its books with spending cuts and tax increases.

The operative word here should, however, be “eventually.” Fiscal austerity will depress the economy further unless it can be offset by a fall in interest rates. Right now, interest rates in Britain, as in America, are already very low, with little room to fall further. The sensible thing, then, is to devise a plan for putting the nation’s fiscal house in order, while waiting until a solid economic recovery is under way before wielding the ax.

But trendy fashion, almost by definition, isn’t sensible — and the British government seems determined to ignore the lessons of history.

Both the new British budget announced on Wednesday and the rhetoric that accompanied the announcement might have come straight from the desk of Andrew Mellon, the Treasury secretary who told President Herbert Hoover to fight the Depression by liquidating the farmers, liquidating the workers, and driving down wages. Or if you prefer more British precedents, it echoes the Snowden budget of 1931, which tried to restore confidence but ended up deepening the economic crisis.

The British government’s plan is bold, say the pundits — and so it is. But it boldly goes in exactly the wrong direction. It would cut government employment by 490,000 workers — the equivalent of almost three million layoffs in the United States — at a time when the private sector is in no position to provide alternative employment. It would slash spending at a time when private demand isn’t at all ready to take up the slack.

Why is the British government doing this? The real reason has a lot to do with ideology: the Tories are using the deficit as an excuse to downsize the welfare state. But the official rationale is that there is no alternative.

Indeed, there has been a noticeable change in the rhetoric of the government of Prime Minister David Cameron over the past few weeks — a shift from hope to fear. In his speech announcing the budget plan, George Osborne, the chancellor of the Exchequer, seemed to have given up on the confidence fairy — that is, on claims that the plan would have positive effects on employment and growth.

Instead, it was all about the apocalypse looming if Britain failed to go down this route. Never mind that British debt as a percentage of national income is actually below its historical average; never mind that British interest rates stayed low even as the nation’s budget deficit soared, reflecting the belief of investors that the country can and will get its finances under control. Britain, declared Mr. Osborne, was on the “brink of bankruptcy.”

What happens now? Maybe Britain will get lucky, and something will come along to rescue the economy. But the best guess is that Britain in 2011 will look like Britain in 1931, or the United States in 1937, or Japan in 1997. That is, premature fiscal austerity will lead to a renewed economic slump. As always, those who refuse to learn from the past are doomed to repeat it.

  • Simon G.

    As usual, slightly economical with the facts. The deficit has been rapidly rising ever since Labour returned to power, to simply blame the financial crisis is wrong. It has to be brought under control, to continue paying out over £40 billion a year in interest payments on ‘Labour’s debt’ is madness.
    As for ‘downsizing the welfare state’, wouldn’t ‘clearing up the mess it inherited’ be more accurate.
    As for comparing Britain 2011 to Britain 1931, don’t be a prat. 1931 – The Great Depression – with 25% unemployment, exactly who’s best guess is that ?

  • That looks like the same Paul Krugman that Labour DID take the advice of at the beginnings of New Labour…

    Krugman wanted to (quote from early last decade) “create a housing bubble to replace the Nasdaq [stock market] bubble”

    “Business investment is not going to be the driving force in this recovery. It has to come from things like housing”

    Krugman has been thoroughly discredited in this crash. He was highly influential and encouraged the banks/government in the creation of a housing bubble which we all know the banks happily obliged by lending cheap mortgages to grow house prices, allow things like mortgage equity withdrawal, and then sell the mortgages for cash to lend out again. UK banks were happy to oblige which is where we are now with a stunningly damaging rise in house prices.

    Always listen to award winning economist Paul Krugman.

  • Sarah Dodds

    It is interesting now to have my head following what my gut was suggesting to me a year or so ago. I don’t know, and still don’t know, much about economics. Much of what I think I know I don’t actually “know”; but feel.
    But what I have learnt is that I am no different to anyone else. Even people who claim to “know” shed loads more than the likes of me don’t have this mythological ability to predict the economic future. Economics is like science – people seem to think of it in terms of factual knowledge, but in fact it evolves, grows and even changes as events and new situations emerge. An indiviual’s politics affects thier economic thinking; not as I naively thought before, the other way around. Cameron and Osbourne attempt to justify thier case because as it is based on economic fact. But I am no longer going to worry about the “facts” of deficit reduction from an economic point of view. Because it’s like arguing about God. People believe one thing so strongly that they are sure it is a “fact.” But those “facts” don’t exist.

    But I present here a few “facts” from the cuts about to hit my county council, (Lincolnshire) as announced just late last night

    “Lincolnshire County Council wants to cut 818 staff by the summer as part of its plans to save £125m from its budget in the next four years.
    A total of 522 of the jobs would be in the children’s services and adult and children’s social care.”

    Just look at that figure again. The majority of jobs and services lost are those that reach the most vulnerable. It is bone chilling.
    My gut tells me that this is morally wrong. My head tells me that cuts like these will turn out (in the long run) costing much, much more than they save.
    But as a right wing friend from the constantly USA tells me, I am just a whinging socialist.

  • Economists on the whole have done very badly over the last decade.

    Common sense has been far more successful than award winning Paul Krugman. It’s pretty obvious you can’t rely on bubbles to encourage government spending above income in the hope the bubble will continue forever but that’s what Krugman wanted and that’s what Labour did. We all know how it ended. There is justification for deficit spending but not encouraged from a bubble which is what Labour did egged on from award winners like Krugman. Absolute fact.

  • Olli Issakainen

    The hedge fund manager George Soros tells David Cameron that Britain´s austerity programme cannot be implemented without pushing the country back to recession. So much for the claims made by the PM that his reckless gamble has international credibility!
    Mr Soros, who famously wrecked the reputation for financial competence of the last Conservative administration, calls Mr Cameron to change direction. Mix of tax increases and spending cuts is unsustainable.
    Economist Nouriel Roubini, who predicted the financial crisis of 2007 and 2008, says that risk of double-dip recession remains in Britain.
    Ed Miliband stated that if David Cameron does not have growth, he never will be able to cut the deficit.
    After George Osborne´s “emergency” Budget – which was all political theatre – forecast for growth was revised downwards. After Mr Osborne mistakenly compared Britain to Greece (a radically different case), consumers stopped spending.
    Mr Osborne should now realize that the shrinkage of the economy is much bigger risk than rising interest rates.
    It is amazing that Very Serious People back Mr Osborne´s ideological plans, as it should be clear to everyone that because of funding gap in the financial system and weak eurozone and demand private sector will not be able to compensate for public sector cuts.
    Time to act is now!
    It is a strategic error on part of the Tory-led government that it thinks that there is no alternative. But as Sir Richard Lambert has stated, the government is taking policy initiatives for political reasons careless of the damage that they might do to business and job creation.
    According to new report financial crisis was caused by corporate mismanagement. 2008 crash was avoidable and was caused by unnecessary risk-taking.
    Collapse of complex insurance products backed by risky home loans caused global financial crisis. Low interest rates brought by the Fed after the 2001 recession did also increase risk-taking.
    According to Ed Balls government is cutting too far and too fast. It has allowed ideology to trump economic pragmatism with falling living standards, higher taxes and rising unemployment to follow.
    The plan to eradicate deficit in one parliament is reckless and dangerous. Growth is important in reducing the deficit.
    Labour would only cut £52bn compared to £81bn. Labour would use active industrial policy. Labour would extend the bankers´ bonus tax.
    Labour must realize that the future is localist, and must develop its economic policy in this way.
    According to Mervyn King it will be back to 1920s this year. Higher imports, energy prices and rising taxes have squeezed take-home pay by around 12%.
    The right thing now for any policymaker is to suspend many planned spending cuts. Yet David Laws recently wrote in the Guardian that cuts were the coalition´s best decision!
    The year ahead will bring inflation, stagflation and higher interest rates.
    Mrs T relaxed policies in 1981 when she realized that things were only becoming worse. George Osborne should also be for turning.
    We are not out of the danger zone yet!

    Ps. John Yates of Scotland Yard said in 2009 that “this case has been subject to the most careful investigation by experienced detectives…no further investigation is required”.

  • alienfromzog

    Not quite absolute fact, Paul Krugman in his own words:

    “One of the funny aspects of being a somewhat, um, forceful writer is that I’m regularly accused of all sorts of villainy. I was personally responsible for the demise of Enron; my nonexistent son worked for Hillary; etc.. The latest seems to be that I called for the creation of a housing bubble — in fact, the bubble is my fault! The claim seems to be based on this piece.

    Guys, read it again. It wasn’t a piece of policy advocacy, it was just economic analysis. What I said was that the only way the Fed could get traction would be if it could inflate a housing bubble. And that’s just what happened.”

    The point Krugman made was that the only way the Fed could drive the economy is response to the DotCom collapse in 2001 was to create a housing bubble. In this analysis he was shown to be absolutely correct. That is not the same thing as advocating it as a wise policy. At no point did he say that this is what anybody SHOULD do.


  • alienfromzog

    Simon, are you using some new definition of the word ‘fact’ that I wasn’t previously familiar with?

    Firstly are you confusing the deficit with debt? The deficit was non-existant in the early years of the last government as the budget was in surplus.

    So, are you claiming that the debt was always increasing? Because it wasn’t. In fact nation debt as a proportion of GDP was lower in 2008 than it was in 1997.(41.92% in 1997, 36.25% in 2008).

    [ / treasury figures]
    But you know, don’t let the facts get in the way and all that…


  • Sarah Dodds

    You two just have just proved my point rather well!!

  • Haha, I’ve seen that response. It’s not just the one article it’s clear what his intentions were from elsewhere. Absolute fact of more of Krugman’s words…don’t listen to Krugman’s own denials! It couldn’t be clearer…

    ““Consumers, who already have low savings and high debt, probably can’t contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery…. But there has been a peculiar disconnect between Fed policy and the financial variables that affect housing and trade. Housing demand depends on long-term rather than short-term interest rates — and though the Fed has cut short rates from 6.5 to 3.75 percent since the beginning of the year, the 10-year rate is slightly higher than it was on Jan. 1…. Sooner or later, of course, investors will realize that 2001 isn’t 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place.”

    “Low interest rates, which promote spending on housing and other durable goods, are the main answer.”

    Get a grip. Things like “are the main answer” does not to me sound like someone doing economic analysis and sounds a lot like advocacy.

    “It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect”

    “please”…he’s begging here!

  • Janete

    Like Sarah, I have no in-depth knowledge of economics and it’s obvious that those who do, hold very different opinions. All we can do is to listen to the arguments, reflect on them in light of our experience and values, and form a judgement.

    I do know that Britain had massive debts after the war but chose to repay them at a steady pace, as it was recognised that investment for a better Britain for everyone, was important as well. I also know that Margaret Thatcher applied the ‘no alternative’ ‘shrink the state’ approach to resolving debt in the 1980s and I witnessed the devastating effect it had on large numbers of people, although importantly, not on all.

    I watched while Thatcher, sold much of our council house stock at knock down prices choosing instead to fund private landlords, (a major problem for the government now). In her desire to encourage property ownership, she allowed building societies and banks to relax their rules on income/mortgage ratio. Rules which had successfully protected borrowers from getting into excessive housing debt and also restrained prices. Of course, some people made lots of money from housing deals at the time, but poorer people were left behind and it was clear we were storing up problems for the future. The lack of affordable housing is now surely one of the most serious problems we face.

    Sadly, these and many other wrong choices, designed to benefit only some people, had been made which Labour could not reverse, as I fear will be the case again, post 2015. My values dictate that I support policies which will benefit the whole population, not just a pushy and privileged few. And my experience tells me Krugman is right and Osborne is wrong, and he correctly warns ‘those who refuse to learn from the past are doomed to repeat it’.

    Of course, if your objective is to create an environment in which a wealthy few can maximize profit at the expense of the rest of us, I suppose it’s possible to agree with Krugman (privately) but choose the Osborne route anyway.

  • You don’t think it’s pretty clear Krugman wanted a house price bubble in his writings?

  • Sarah Dodds

    Depends which shoes you want to walk in.

  • The shoes which don’t try and pretend that when someone writes an article and puts “Low interest rates…are the main answer” and “let’s have at least one more rate cut, please” is actually economic analysis and not the simple truth.

  • Sarah Dodds

    Chris, how many circles do you want to dance round in? I can actually read it both ways quite easily. If you can’t no problem.

  • Looks like I’ll have to simplify the question…In what way can you read statements like “needs”, “…are the main answer”, and “please” as economic analysis and not advocacy? Not a rhetorical question.

  • Sarah Dodds

    *****Bangs head against desk in desperation*****

    I am not saying you are wrong. I am not saying you are right. I am simply saying that you can take Krugman’s comments and read them in any way that suits your political view, and that your political view will determine how you respond to them.

  • That doesn’t make any sense. This isn’t a political thing. It’s basic logic. Take these statements…

    “The top 10% of earners in country X pay Y% of their earnings in tax”

    “The top 10% of earners in country X are over taxed and should be taxed less”

    Which is economic analysis (even if it is flawed)? Which is a political viewpoint? You’re very confused about basic things.

    So not so “Simples”. There are no two ways of reading the situation no matter how hard you want to bang your head against your desk.

  • Sarah Dodds

    CBA anymore Chris.

    I’m really happy to come on this site, air my views and listen to others carefully as someone who is learning the ropes when it comes to politics. I’ve learnt alot from the people on here, and gain as much from their comments as I do from the blog itself. Although I do read other blogs, I’m not that confident about leaving comments because of the harshness of some of the responses. If you come on here to prove that you are right about everything then that’s really sad and speaks volumes about your attitude and sincerity.
    My original comment still stands – people will/can /do use ANY ecomomic argument if it fits thier political views. If they don’t like it they disregard it. You and whoever it was above commenting as well did exactly that, and I can see both sides. I’m not going to kiss your boots and bow down to your superior wisdom.

  • Never asked you to kiss my boots or claim I have superior wisdom.

    “My original comment still stands – people will/can /do use ANY ecomomic argument if it fits thier political views.”

    But that’s just it…it’s not an economic argument. It’s an argument over whether using words like “need” and “please” are economic analysis or not. It clearly isn’t.

    Labour and the Conservatives AGREE on whether VAT is 20% or not (analysis) but they don’t agree on whether it’s a good thing (opinion).

    If I tell you I have a red car when I actually have a blue car. It’s not something that can be seen two ways.

    This thread started with you explaining you didn’t know much about economics. The assertion is clearly that “award winning” economist does know about economics. I effectively pointed out to you that you don’t need to know about economics because economists have done very badly in the last decade (the mainstream did NOT see this coming) since it is clear that Krugman advocated things that were obviously bad. The argument then drifted into whether Krugman was simply providing analysis or an opinion. It’s more than clear it wasn’t analysis since he was literally begging for changes by governments.

    And so we are here where you say it’s a perfect example of a political argument. It isn’t. For the n-th time it’s an argument about the obvious difference between an analysis and advocacy.

    I’m not trying to knock you down, or pretend I know more than anyone else, in fact, if anything, I was reassuring you that you don’t need to know about economics because it’s value has been put in doubt in the last decade. I hope you can see that.

  • Sarah Dodds

    I wasn’t going to come back to you Chris, but after something went ping in my head yesterday I realised that you could not possibly know my train of thought….so here goes.
    I totally understand the difference between analysis / opinion and if I was a bit terse yesterday it was because my kids were brats, work was crap and I hate it if I think I’m being patronised. Not a good combination. The reason I pay any attention to anything here and elsewhere on the net is it is how I get my news, the reason being that I have so little faith in anyone in the media. I am sick to death of being given what should be an “impartial expert analysis”, only to find a whole bunch of other facts just around the corner that they have air brushed over. I am not saying that you have been at all dishonest Chris. But if anyone else was reading this (and I don’t think anyone else is by now!) I have no doubt that someone would come up with yet another article/interview that would blow open your points again. I simply not well enough informed to make a judgement one way or another as to whether yours is the final say to this. That is why I say I can see both sides – not because I don’t understand. The context Krugman was in, the intended audience of his article and his ability to influence policy are all factors I don’t know enough about him to judge his ultimate intent. The fact he so forcibly denies the housing bubble claim also DOES count for something, even if you claim it does not. As does his natural desire to distance himself from the results if that was what he did….
    The joy of blogs for me, especially this one, is that nobody pretends to be neutral when they are not. Everyone is quite open to the fact that they are biased one way or another- there is no phoney attempt at impartial analysis. Everyone here needs to be taken with a pinch of salt (Alastair Cambell included!), and if my pinch is too harsh at times I no longer care. But there is an integrity about not having to beat around the bush when it comes to your own particular bias that is a breath of fresh air for me, and I will remain cycnical about anybody using the term “analysis” until my last breath.