By Cormac Lucey
Having been at the top of politicians’ priorities for the past decade, austerity is fast falling out of fashion. Our new Taoiseach, Leo Varadkar, wants to boost infrastructure with his predecessor’s rainy day fund. Donald Trump wants to stimulate American economic activity by cutting taxes.
It has even been reported that a split has emerged in the UK government between the chancellor Philip Hammond and other ministers over whether to raise taxes to pay for more spending on public services.
The Conservatives not only want to increase government spending but wish to use additional borrowing to finance it. Yes, that’s Margaret Thatcher you can hear, spinning in her grave.
There are a number of strange things about this sudden unpopularity of austerity. First, in terms of managing the business cycle, there is no justification to increase government deficits today in either Ireland, the US or the UK.
Having just raised interest rates, Janet Yellen, chairwoman of the US Federal Reserve, announced that the economy was doing fine and unemployment was back around pre-recession levels. “Fiscal policy is not obviously needed to provide stimulus to help us get back to full employment,” she said.
The pattern of unemployment rates over the past decade bears out Yellen’s observation. Having risen sharply between 2008 and 2012, unemployment rates in Ireland, the US and the UK have fallen back to their lows of a decade ago.
Ireland is the only exception: the unemployment rate fell below 5% in the late Noughties before it rose to nearly 15% at the height of the crisis. It has since fallen to just over 6%. We haven’t quite got back to boom-time employment levels, but we’re not far off it.
Given the positive economic numbers and plummeting unemployment, why is budgetary relaxation on the agenda in Ireland, the US and the UK? It seems that political imperatives are winning out over logic. The Charlie McCreevy doctrine of “if I have it, I spend it” has gone global. This is the very opposite of how Keynesianism is supposed to work.
An IMF article, What Is Keynesian Economics?, explains: “Keynes advocated so-called countercyclical fiscal policies that act against the direction of the business cycle.” Keynesian economists advocate deficit spending on labour-intensive infrastructure to stimulate employment and stabilise wages during economic downturns. They would raise taxes to cool the economy and prevent inflation when there is abundant demand-side growth. Politicians don’t have any problem loosening the purse strings; it’s tightening up they struggle to practise.
The second strange aspect of austerity’s sudden unpopularity is that, while the sharp rise in unemployment occasioned by the economic crisis has been largely reversed, the damage to government finances has not.
Nearly a decade after the outbreak of the downturn, governments are still spending more each year than they are taking in. This year, the Irish government is running a deficit. So are the American and British governments. The debt levels of these governments are sharply higher compared with a decade ago. Yet further budgetary relaxation is now considered.
The third oddity is that the rejection of austerity is by politicians who are nominally conservative. Varadkar has been branded “Thatcherite” by some of his opponents. Trump is a billionaire leading a Republican administration. The British government is populated by Conservatives who came of age during Thatcher’s heyday.
Yet these are the very politicians who want to increase spending even though there is little economic case for it at this late stage of the economic cycle. How so?
James McGill Buchanan (above) is a Nobel-prize winning US economist, best known for his work on public choice theory. It focuses on how politicians’ and bureaucrats’ self-interest, utility maximisation and other non-wealth considerations affect decision-making.
In a work he co-authored, Democracy in Deficit: The Political Legacy of Lord Keynes, Buchanan argued that the legacy or heritage of Keynes was “the putative intellectual legitimacy provided to the natural and predictable political biases toward deficit spending, inflation and the growth of government”.
Politicians use those bits of Keynesianism that suit them, happily running budget deficits in bad times, but ignore those parts that don’t suit, such as the need to run a surplus in good times. Like a trolley with a defective wheel, politicians structurally misdirect economies towards deficits and ever greater government intervention.
Another problem is the professionalisation of politics. Decades ago, when politics was the realm of the gifted amateur, the long-term needs of government predominated over the short-term concerns of ministers seeking re-election. As politics has become more professional, that has reversed. Today, short-term political needs outweigh the requirements of good government.
One way to put sand in the motor of these burgeoning political prerogatives is to create institutions which lean against the process. Here in Ireland we have the Irish Fiscal Advisory Council (Ifac). Internationally, we have the Bank of International Settlements (BIS), which started life as a clearing house for German reparation payments after the Second World War. It has since morphed into a think-tank for central bankers.
The BIS’s recent annual report states that the biggest dangers ahead for the global economy are rooted in the “risky trinity” of low productivity growth, high debt levels and unusually limited room for policy manoeuvre. The BIS reckons that best course forward is to take advantage of current economic growth by raising each economy’s growth rates through further structural reforms.
Ominously, the BIS warns: “The main source of near-term concerns in crisis-hit economies is the failure to fully repair banks’ balance sheets in some countries, notably in parts of the euro area, especially where the public sector’s own balance sheet looks fragile. Political uncertainties compound these concerns.” Ireland ticks all the warning boxes, even though we weren’t explicitly name checked.
The BIS’s big worry is that the main cause of the next recession will “perhaps resemble more closely that of the latest one — a financial cycle bust”. Prolonged ultra-low interest rates have led to a sharp rise across the developed world in zombie companies, where operating profits don’t cover interest costs.
The BIS and IFAC can do little more than cry wolf. No matter how convincingly they do so, politicians won’t respond to their warnings if citizens demand ever more government spending and ever lower taxes.
Published in The Sunday Times (Irish edition)
July 16th 2017