Austerity Cant Work; Time for an Alternative that Offers Hope

By Grahame Morris MP

More than four years after the financial crisis began; the world’s major advanced economies remain depressed, in a situation any student of economic history can confirm is all too reminiscent of the 1930s. The reason is simple; we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.

The Tory narrative that you can’t get out of a debt crisis by incurring more debt has been willing taken up by right wing commentators has taken deep root in the public consciousness. It has until now, provided the public support for the excessive austerity of current fiscal policies in many countries across Europe. At this stage in the political cycle the time is right for a Manifesto to be developed by which mainstream economists can inform Labour’s alternative economic strategy and offer the public a more evidence-based analysis and solution to our economic problems in the UK.

Many policy makers insist that the current crisis in the advanced economies was caused by irresponsible public borrowing. With very few exceptions – other than Greece – this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by banks over extending themselves. The collapse of this bubble led to massive falls in demand, employment and thus in tax revenue. The large government deficits we see today are a consequence of the crisis, not its cause.

The nature of the present crisis is that when property bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to repay past debts. This was a rational response on the part of individuals, but – just like the similar response of debtors in the 1930s, it has proved collectively self-defeating, because one person’s spending is another person’s income. The result of the spending collapse has been an economic depression that has worsened the public deficit.

The appropriate response at a time when the private sector is engaged in a collective effort to spend less, is that public policy should act as a stabilizing force, attempting to sustain spending. At the very least we in the UK should not be making things worse by big cuts in public spending or big increases in direct and indirect taxes on ordinary people. Unfortunately, that’s exactly what David Cameron and George Osborne are now doing.

This is a huge error of judgement. After responding well in the first, acute phase of the economic crisis, under Gordon Brown’s stewardship, conventional policy wisdom took a wrong turn – focusing on immediate and deep reduction in the UK government deficit, which was mainly the result of a crisis-induced fall in revenues, and increased costs of benefits as unemployment has increased. Arguing that the public sector should attempt to reduce its debts in parallel with the private sector, is exaggerating the crisis of confidence and demand. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing and exacerbating the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could in theory relieve some of the pressure. The problem is in the UK with interest rates close to zero, monetary policy – while it has a role to play, cannot do the whole job. There must of course be a medium-term plan for reducing the deficit. Osborne’s economic plan however is too front-loaded it is self-defeating by undermining the recovery. A key priority now must be to reduce unemployment especially youth unemployment, before it becomes endemic with all the individual misery it brings as well as the risks and costs of creating a lost generation. It is also making recovery and future deficit reduction even more difficult.

The Tory LibDem Coalition deploy two quite different arguments in support of their case.

The first of these is the confidence argument. Their main argument is that increasing spending will increase the UK government deficit which will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.

There is no credible evidence to support this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank.

This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies have had no effect on Japanese interest rates.

Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the Central Bank in our case the Bank of England can always, if needed, fund the deficit, leaving the bond market unaffected. Moreover history tells us that there are no relevant examples where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main method employed was a currency depreciation against a strong world market, not however a current possibility for countries in the Eurozone.

The lesson of the IMF’s study is clear – budget cuts inhibit recovery. That is precisely what is happening now – look at the example of Ireland, the countries with the biggest budget cuts have experienced the biggest falls in growth and employment.

For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can be confident there are enough customers with enough income to spend. Austerity discourages investment. There is massive evidence against this bogus confidence argument; all the alleged evidence in favour of the doctrine has evaporated on closer examination.

The second argument is a structural argument. Those on the right contend that the obstacle to expanding demand is that production is in fact constrained on the supply side by structural imbalances. If this theory had credence, however, at least some parts of our economy should be growing. In most countries that is just not the case including the UK, every major sector of our economy is struggling, and almost every sector has higher unemployment than usual. Therefore the problem must be a general lack of spending and demand. In the Great Depression of the 1930s the same structural argument was used against proactive spending policies in the United States and in the UK. As spending rose with economies steeping up war production between 1939 and 1945, output increased dramatically. Thus the problem in the 1930s, as now, was a lack of demand not of supply.

The result of their mistaken analysis, is that many European and American policy-makers & politicians are inflicting massive suffering on their peoples. The ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root.

We can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment, cuts in benefits and social programmes.

Appropriate policies will differ between countries and need detailed debate but they must be based on a correct analysis of the problem. As a Member of Parliament representing the Easington constituency in the North East of England amongst the hardest hit by the present Coalition Government’s policy of austerity I have joined politicians, economists, trades unionists and community activists to sign up to an Alternative Manifesto for Economic Sense here

I would urge others to do likewise register their support and to argue publicly the case for a sounder evidence based approach to our current economic crisis. The whole world suffers when good men and women remain silent about what they know is wrong.

Twitter: @GrahameMorris | Website: Grahame Morris MP

2 thoughts on “Austerity Cant Work; Time for an Alternative that Offers Hope

  1. jayarava

    Hi Grahame

    It’s great to see Labour politicians embracing these kinds of ideas. I believe we must have a genuine change in our economic policy in the direction you are indicating.

    Austerity is just a smokescreen for an ideologically driven destruction of the state. It won’t achive prosperity, but will make government a lot smaller.

    We desparately need to set about discrediting the Chicago School of economic thought and exploring the alternatives as sources of inspiration and innovation.

    So yes. Great, can’t wait to hear Ed and Ed talking about these kinds of policies. When will that be do you think?

    BTW While I think the Manifesto makes a lot of sense, I don’t think it goes far enough, especially when it comes to dealing with the parasites in the finance sector.

    I could add a lot more, but let me boil it down to one suggestion. When taking advice on economic policy the Labout Party should only invite economists who publicly predicted the 2007 crisis at least a year before it happened. Failure to predict the 2007 crisis means that an economist is unqualified to give advice on the economy because empirically they obviously don’t understand it. I can supply a list of names of economists who did predict the crisis if you like — it’s quite short. But start by talking to Ann Pettifor.

    If Labour adopts these kinds of economic policies I will not only vote for you, I’ll campaign!


    Either the Neo-Liberals wish to pursue this policy in order to create global conflict, or they are totally ignorant of what clearly has a historical precedent.It has to be one or the other, for their is no other explanation for their clinging to what will ultimately end up in a War hitherto unseen on the face of this earth.


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