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The Economic Consequences of Mr. Osborne

Author(s): Niall Ferguson

In the wake of the 2010 British election, Keynesians like Robert Skidelsky predicted that Chancellor of the Exchequer George Osborne was gravely wrong in seeking to reduce the budget deficit. It turns out that it is the Keynesians who were mistaken, with the main question being why they refuse to admit it.

From Project Syndicate:

“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 now.

Long before the United Kingdom’s recent general election, which the Conservatives won by a margin that stunned their critics, the facts about the country’s economic performance had indeed changed. Yet there is no sign of today’s Keynesians changing their minds.


Because I admire him as an historian, not least for his Keynes biography, I omitted Lord Robert Skidelsky’s name from my post-election commentary critiquing the contemporary Keynesian take on the UK economy. Opprobrium was best heaped, I believed, on Paul Krugman, as he makes such a virtue of heaping it on others. Unwisely, Skidelsky has leapt to Krugman’s defense.

Let me restate why the Keynesians were wrong. In the wake of the 2010 British election, Skidelsky, like Krugman, predicted that Chancellor of the Exchequer George Osborne was gravely wrong in seeking to reduce the budget deficit. In November 2010, he 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,” warning that financial markets might soon lose confidence in his policies.

In June 2012, Skidelsky argued that “since May 2010, when US and British fiscal policy diverged, the US economy has grown – albeit slowly. The British economy is currently contracting. … For Keynesians, this is not surprising: By cutting its spending, the government is also cutting its income. Austerity policies have plunged most European economies (including Britain’s) into double-dip recessions.” And, in May 2013, he reported that “The results of austerity had been “what any Keynesian would have expected: hardly any growth in the UK … in the last two and a half years … little reduction in public deficits, despite large spending cuts;…higher national debts… [and] prolonged unemployment.”

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 confidence (the “confidence fairy”).

Just a week before the UK voted this month, Skidelsky speculated that voters, “still wobbly from Osborne’s medicine,” might “decide that they should have stayed in bed.” Instead, the Tories won an outright majority, confounding pollsters and Keynesians alike. What could possibly have gone wrong – or, rather, right?

The last-ditch argument now put forward by Krugman is that the UK electorate was fooled into voting Conservative by a one-year pre-election boom, cynically generated by a covert Keynesian stimulus. It cannot have been easy for him to abandon his cherished macroeconomic model in favor of a conspiracy theory, especially one that two decades ago lost whatever explanatory power it ever had for UK elections.

But there is an alternative explanation: the Keynesians were wrong. “Austerity” was not nearly as harmful as they predicted. Fiscal stabilization may have contributed to a revival of confidence. In any case, nothing in modern British economic history told Osborne that he could risk running larger deficits with impunity.

There has been some sleight of hand in assessing Britain’s recent economic performance. For example, Dean Baker took International Monetary Fund data for the G-7 countries’ GDPs and made 2007 his base year. But a more appropriate benchmark is 2010, in the middle of which Cameron and Osborne took office. It is also worth including the latest IMF projections. And per capita GDP must surely be preferable to aggregate GDP.



No doubt, recovery in the UK began more slowly than in other G7 economies, except 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 IMF, only the US economy will grow faster over the next four years, with the UK then regaining the lead.

It is wrong to assume that the UK could somehow have replicated the German or American recovery, if only Keynesian policies had been followed. The UK’s position in 2010 was exceptionally bad in at least four respects, and certainly much worse than that of the US.

First, public finances were extremely weak, as a 2010 Bank for International Settlements study of trends in debt-to-GDP ratios clearly showed. The baseline scenario for the UK at that time was that, in the absence of fiscal reform, public debt would rise from 50% of GDP to above 500% by 2040. Only Japan was forecast to have a higher debt ratio by 2040 in the absence of reform.

Second, including financial-sector debt, non-financial business debt, and household debt the pre-crisis UK had become, under Labour governments, one of the world’s most leveraged economies. In 1997, Labour’s first year in power, aggregate UK debt stood at around 250% of GDP. By 2007, the figure exceeded 450%, compared with 290% for the United States and 274% for Germany. Government debt was in fact the smallest component; banks, businesses, and households each had twice as much.

Third, inflation was above the Bank of England’s target. From 2000 until 2008, the inflation rate had crept upward, from below 1% to 3.6%. Among G-7 countries, only the US rate was higher in 2008; but, whereas US inflation cratered when the crisis erupted, the UK rate remained stubbornly elevated, peaking at 4.5% in 2011.


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