Photo: Phil Noble/Reuters
Photo: Phil Noble/Reuters

Niall Ferguson | The economic consequences of Mr Osborne

While the facts have changed, there is still no sign of the Keynesians changing their opinions

“If the facts change," John Maynard Keynes is supposed to have said, “I change my opinion. What do you do, sir?" It is a question his latter-day disciples should be asking themselves today.

Long before this month’s general election in the UK, which the Conservatives won by a margin that stunned their critics, the facts about British economic performance had indeed changed. Yet there is still no sign of the Keynesians changing their opinions.

Because I admire him as an historian, not least for his magisterial Keynes biography, I omitted Lord Robert Skidelsky’s name from my post-election commentary. It seemed to me that the opprobrium was best heaped on Paul Krugman, as he makes such a virtue of heaping it on others. But Skidelsky stood shoulder to shoulder with Krugman. They both predicted that UK chancellor of the exchequer George Osborne was making a grave mistake in seeking to reduce the budget deficit.

Speaking in November 2010, Skidelsky described Osborne as “a menace to the future of the economy" whose policies “doomed (the UK) to years of interminable recession". In July 2011, he told the Financial Times that Osborne was “making a wasteland". In June 2012, he argued that “the British economy is currently contracting". Six months later, he insisted that Osborne’s policies were “slowly strangling our economic life".

By this time, groupthink had taken hold. Skidelsky approvingly quoted Krugman’s claim that Britain was “doing worse this time than it did during the Great Depression". More than once he echoed Krugman’s assertion that Osborne had been motivated by an erroneous belief that if he did not reduce the deficit, he might forfeit investor sentiment (the “confidence fairy").

We can see now that the Keynesians were wrong. On the basis of per capita gross domestic product (GDP), the UK recovery was slower to get off the ground than those of the other G-7 economies, with the sole exception of Italy. But there is also no doubt that the UK recovery picked up speed after 2012. Last year, its growth rate was the highest in the G-7. According to the International Monetary Fund (IMF), only the US economy will grow faster over the next four years, with the UK then regaining the lead.

Yet all such simplistic comparisons overlook the fact that the UK’s position in 2010 was exceptionally bad in at least four respects, and certainly much worse than that of the US.

First, the UK’s public finances were in exceptionally bad shape, as a 2010 Bank for International Settlements study of trends in public debt ratios to GDP clearly showed. Second, taking into account not only government debt, but also financial sector debt, non-financial business debt, and household debt, the UK was one of the most leveraged economies in the world even before the crisis began. Third, inflation was persistently above the Bank of England’s target. And, finally, despite (mercifully) being outside the eurozone, the UK was much more exposed than the US to the single currency’s 2012-13 crisis.

So how did Osborne do against these daunting challenges?

Let’s start with the fiscal numbers. Government net debt had soared from 38% of GDP to 69% from 2007 to 2010. It has continued to rise under Osborne, but at a far slower pace, and is forecast to peak at 83% this year, after which it will decline. By 2020, if IMF is right, only Canada and Germany will be in better fiscal health.

The stabilization of public debt has been achieved by a drastic reduction of the government’s deficit, from a peak of just under 11% in 2009 to 6% last year. By 2018, according to IMF, the deficit will have all but vanished. Much the same story can be told about the government’s structural balance.

This is an impressive performance in comparative terms. The US, for example, will still have a 4%-of-GDP deficit by 2020 by either of the above measures.

What, then, was the economic and social cost of Osborne’s successful fiscal stabilization?

As we have seen, the double-dip recession predicted by Keynesians did not occur. In terms of unemployment, the UK did well. Its jobless rate never rose as high as it did in the US and Canada in the teeth of the crisis, and it currently stands at roughly half the rates in Italy and France.

Measured by job creation, too, UK performance was as good as the best, with employment increasing by roughly 5% from 2010 to 2014. As Jeffrey Sachs has noted, the UK actually outperforms the US in terms of its employment rate, which is now at a record-high 73%, compared with 59% in the US.

The fact of the matter is that the more Krugman and Skidelsky talked about the “confidence fairy", the more confidence returned to UK business. One can argue about why that was, but it seems unlikely that fiscal consolidation was irrelevant.

As for the Keynesians’ comparisons with the Great Depression, these were plainly risible from the outset. In terms of unemployment, even the recessions of the 1980s and 1990s were twice as painful.

An important feature of Keynes’s work was his emphasis on full employment as a goal of policy. His greatest work is called The General Theory of Employment, Interest and Money, not The General Theory of Real Earnings. Nevertheless, it is on the question of real earnings that the Keynesians, led by Jonathan Portes, mounted a last desperate stand on Twitter in response to my post-election article.

Without question, the pain was real. Average inflation-adjusted weekly earnings fell more than under any postwar government. On the other hand, did Portes & Co. celebrate the achievements of the Thatcher government, which was the most successful of postwar governments by this measure? I rather doubt it. And I would imagine they would have been less happy if Osborne and Prime Minister David Cameron had presided over a jump in real earnings that coincided with a doubling, rather than a halving, of the unemployment rate.

In any case, we now find ourselves, in all likelihood, at the halfway mark of the Cameron era. As the electorate has wisely decided, the right time to draw a conclusion about this government’s performance in terms of real earnings will be in 2020, not in 2015. The good news is that since September 2014, earnings have been growing in real terms, too. The plunge that began under Gordon Brown took time to stop, but it is finally over.

Like Krugman (though his tone has been much less obnoxious), Skidelsky has made the very un-Keynesian mistake of sticking to an erroneous view in the face of changing facts. I look forward to the day when they and all their confederates have the intellectual honesty to admit that they were wrong – horribly wrong – about the economic consequences of Osborne’s strategy. ©2015/PROJECT SYNDICATE

Niall Ferguson is Professor of History at Stanford and a senior fellow of the Hoover Institution.

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