Someone reading my recent post on major UK macro policy errors asked whether my blog was becoming more political. I hope not, in the sense of being party political for its own sake. However, when the issue involves macroeconomic policy, then I do my best to say what I think is right rather than what is politically expedient. This is in part because I have very negative views about the role of ideology (left or right) in influencing economics. (Incidentally, I do react badly to those who say ‘ah, but all theory is ideological, it’s just that you pretend what you do is ideology free’. I guess this makes me one of those old fashioned fogeys who believe in the possibility of evidence based social science.)
Perhaps this is why I have not so far explicitly commented on the oft repeated refrain by the current government that austerity is necessary to ‘clear up the mess’ left by excessive deficits under Gordon Brown? It is nonsense of course, but like all the best slogans it contains a half-truth. I think it is certainly true in hindsight, and almost certainly true ex ante, that spending in the later Brown years was underfunded (or excessive, depending on your viewpoint). By exactly how much I plan to explore in more detail for a paper over the next few months. The untruth, of course, is that this problem had to be corrected immediately and quickly during a recession.
This issue arose from my recent post where I listed what I considered to be the three major UK macroeconomic policy errors over the last 30 years. I said that underfunded spending by Brown was an error, but that I did not consider it a major one because it did not lead to the same scale of welfare losses that occurred when unemployment became unnecessarily high (like now). Chris Brown commented that “The loss in social welfare [caused by excessive deficits in a boom] is never felt at the time of the increase in government spending (the reverse is true) but after the party is over (i.e. today)”.
I think this comment is right in two ways, but nevertheless it does not imply that Brown’s underfunding was a major error. Let’s start with where I agree. First, additional spending paid for by debt which is then paid off at some future date by cutting spending clearly raises welfare today but reduces it tomorrow. If the additional debt is paid for by raising future taxes (i.e. we are permanently increasing the size of the state) then the situation is more complicated. If consumers are completely Ricardian then the timing of the tax increase does not matter for welfare, but let’s leave that complication to one side. Second, I agree that pro-cyclicality in spending decisions is a common vice, and that because it tends to be asymmetric (it happens more often in booms than recessions) it can lead to deficit bias. This is certainly bad policy.
But are the welfare costs of this that high? Not, in my view, if the subsequent correction is done at the appropriate time. To take a simple case, suppose monetary policy is able to completely offset the demand impact of both the excessive spending, and the subsequent cut in spending designed to pay off the additional debt. The only welfare cost then is an intertemporal misallocation of public goods. It is my judgement that these costs are of an order smaller than the costs created by raising unemployment by a few hundred thousand for a few years when unemployment is already high. (I have to say judgement here, because most formal analysis of measuring the welfare costs of business cycles takes place in representative agent models where ‘unemployment’ just means everyone working a few less hours. This does not begin to capture the true impact of unemployment on well being.)
Now if it was true that the additional unemployment caused by austerity today was an inevitable consequence of underfunding in the Brown years, then the comment would be exactly right. But it is not. Paying off the debt created by the underfunding should be done during the next boom, and not now. As a result, Gordon Brown’s error gets relegated to minor status when compared to what is happening now.