Last month, Vox Political wrote to the Chancellor of the Exchequer, a Mr Osborne, politely asking him whether he had any other documentary justifications for his disastrous programme of austerity after the previous principal pillar of his faith – a paper by Harvard economists Reinhart and Rogoff – had been disproved by a student at a rival university.
Today we received a response! A lengthy, well-considered one at that.
What a shame that we found a way to trash it before we reached the end of page one.
But we’re getting ahead of ourselves. Let’s all read the letter together, shall we? It begins:
“Thank you for your letter dated 22 April about the recent publication by Herndon, Ash and Pollin, a critique to the paper ‘Growth in the time of Debt’ by Reinhart and Rogoff.
“You asked for the Treasury’s views on the recent criticism of the paper by Carmen Reinhart and Kenneth Rogoff which concluded that public debt above 90% of GDP could prove a significant drag on economic growth.
“As you will be aware, the Coalition Government inherited the largest deficit in post-war history due to unsustainable increases in Government spending by the previous Government and the effects of the financial crisis [We don’t know that at all. The largest deficit in post-war history is something to which this writer cannot respond – I only know that the national debt at the end of WWII was 250 per cent of GDP, or very nearly four times as much as it is now. Spending by the Labour administration was less than that of the Conservatives until the financial crisis took place, so the writer is effectively admitting that Conservative spending between 1979 and 1997 was even more unsustainable. As for the financial crisis, the Tories would have done the same as Labour at the time, as is borne out by the history books]. In order to address these problems the Coalition Government set a clear and credible consolidation plan to reduce the risks of a costly loss of market confidence in the UK, to restore confidence and underpin sustainable growth.
“As noted by the OECD in their Economy Survey of the United Kingdom February 2013, ‘global developments have shown that the consequences of loosing [sic] market confidence can be [a] sudden and severe and sharp rise in the interest rates [that] would [be] particularly damaging to an economy with the United Kingdom’s level of indebtedness.’ A 1 percentage point increase in government bond yields would add around £8.1 billion to annual debt interest payments by 2017-18.
“Fiscal consolidation also reduces the risk of adverse feedback between weak public finances and a strained financial sector. This feedback can be very damaging, as evidenced by recent events in the euro area. Globally, the UK has one of the largest financial systems relative to the size of its economy, meaning that any loss of investor confidence in the UK’s fiscal position would not only affect the UK, but also the global economy. As the IMF has stated in their United Kingdom – 2011 Article IV Consultation Concluding Statement of the Mission, ‘the UK financial system thus serves as a global public good’. It is the IMF’s view that the UK’s economic and financial sector policies have a systemic impact on the global economy.
“The Government’s approach is supported by a large body of academic and professional literature which finds that there are strong theoretical and empirical grounds for a relationship between high levels of debt and slow growth, including:
“1. Work by staff of the Bank for International Settlements:
“* ‘The Real Effects of Debt’ by Cecchetti et al, 2011 (published as a Bank of International Settlements working paper in September 2011), found that government debt above 85% had a negative impact on growth.
“2. Research by staff of the International Monetary Fund:
“* ‘Public Debt and Growth’, an IMF 2010 working paper prepared by Kumar and Woo, found that an increase in debt ratio of 10& resulted in an annual decrease of 0.2% in per capita GDP growth, with a stronger effect at higher levels of debt. The paper found some evidence of nonlinearity with higher levels of initial debt having a proportionately larger negative effect on subsequent growth. Analysis of the components of growth suggested that the adverse effect largely reflects a slowdown in labour productivity growth mainly due to reduced investment and slower growth of capigal stock.
“* ‘How costly are debt crises’, an IMF 2011 working paper prepared by Furceri and Zdzienicka, finds that debt crises produce significant and long-lasting output losses. This study also provides support to the idea of a threshold for the debt-to-GDP ratio above which output growth starts to decline.
“* The IMF 2013 WEO box 1.2 ‘Public Debt Overhang and Private Sector Performance’, cites studies that have found a threshold beyond which public debt harms growth. It also lists several reasons why a debt overhang can affect economic activity.
“3. Work by staff of the Organisation for Economic Co-operation and Development:
“* ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ Egert, OECD 2012, finds ‘some evidence in favour of a negative nonlinear relationship between debt and growth using a variety of econometric models.
“4. Work by staff of the European Commission:
“* Report on Public Finances in EMU 2012 supports the statement that public debt can trigger economic growth: ‘higher debt levels and interest rates might weigh on economic growth, especially when debt exceeds a certain threshold level as a number of papers suggest.’
“There are also theoretical reasons, highlighted in Boskin, 2012 and OECD, 2012 for believing that higher levels of public debt will damage medium-term growth prospect:
“* First, tax hikes needed to service a higher public debt may crowd out private investment by reducing disposable income and saving.
“* Second, if the higher debt servicing costs associated with increased debt levels are financed by increasing tax revenue, they also imply a deadweight loss on the economy as a result of distortionary effect of raising tax revenues.
“* Third, there is broad agreement that large deficit and debt levels are associated with a higher level of long-term Government bond yields which may crowd out productive public investment and reduce private investment through an increase in the cost of capital. Reduced investment in research and development will have long-lasting negative impacts on growth.
“The approach is also supported by international organisations. The OECD, for example, noted in its November 2012 Economic Outlook that ‘With the budget deficit (excluding temporary factors) at over 8% of GDP and gross government debt at over 80% of GDP, fiscal consolidation is necessary to restore the sustainability of public finances and will strengthen medium-term growth prospects. The fiscal stance remains appropriate, and is supported by the strong institutional framework.’
“Olli Rehn, Vice President of the European Commission, on the speech of the Spring Forecast in May 2013 noted: ‘It is important that the UK follows through with consistent consolidation of public finances with a view to achieve (sic) a more sustainable fiscal position.’
“At the end of this letter you can find the papers referred to above online.”
I shan’t embarrass the letter’s author by naming that person.
The online papers are:
Cecchetti, Bank of International Settlements, 2011. ‘The Real Effects of Debt’ http://www.bis.org/publ/work352.htm
Kumar and Woo. ‘Public Debt and Growth’, IMF 2010 http://www.imf.org/external/pubs/ft/wp/2010/wp10174.pdf
Furceri and Zdzienicka. ‘How Costly are debt crises’, IMF 2011 http://www.imf.org/external/pubs/ft/wp/2011/wp11280.pdf
IMF April 2013 World Economic Outlook (WEO) http://www.imf.org/external/pubs/ft/weo/2013/01/
Egert, OECD 2012. ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ http://www.oecd-ilibrary.org/economics/public-debt-economic-growth-and-nonlinear-effects_5k918xk8d4zn-en
Boskin, M. Stanford Institute for Economic Policy Research, 2012. A Note On the Effects of the Higher National Debt On Economic Growth http://siepr.stanford.edu/publicationsprofile/2491
OECD Economic Outlook, November 2012. http://www.keepeek.com/Digital-Asset-Management/oecd/economics/oecd-economic-outlook-volume-2012-issue-2_eco_outlook-v2012-2-en
European Council, 2012 UK Country Specific Recommendation (CSR). http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/20_scps/2012/04_council/uk_2012-07-10_council_recommendation_en.pdf
… all of which can be picked apart with one observation and a couple of attached questions:
Mr Osborne demanded in 2010, that cuts to welfare benefits alone should total £18bn per year by 2014-15 (meaning a total of £90bn over the five years of Coalition government). Other government departments have had to take huge hits as well.
So why is the total drop in the deficit this year just £300 million? And why is the national debt now more than 88 per cent of total GDP – well inside the danger zone that Mr Osborne has been trying to avoid?
Could it be that, once put into practice, the theories outlined above aren’t actually worth a farthing?
Expect much more on this subject as we really get our teeth into the material the Treasury has kindly provided.