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The Consequences of the Global Financial CrisisThe Rhetoric of Reform and Regulation$

Wyn Grant and Graham K. Wilson

Print publication date: 2012

Print ISBN-13: 9780199641987

Published to Oxford Scholarship Online: September 2012

DOI: 10.1093/acprof:oso/9780199641987.001.0001

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The United Kingdom: The Triumph of Fiscal Realism?

The United Kingdom: The Triumph of Fiscal Realism?

(p.34) 3 The United Kingdom: The Triumph of Fiscal Realism?
The Consequences of the Global Financial Crisis

Andrew Gamble

Oxford University Press

Abstract and Keywords

The financial crash of 2008 ended a long period of growth in the British economy. Measures taken to prevent the crash turning into a slump transformed the banking crisis into a fiscal crisis, with the result that how to handle the resulting deficits dominated UK politics before the 2010 election. Debate focused on how quickly the deficit should be reduced, whether this was a structural or cyclical deficit, and what policies were needed to maintain the confidence of the financial markets. After the election, the Coalition Government announced plans to eliminate the deficit within five years. This marked a return to fiscal conservatism and a politics of austerity, but the plans aroused skepticism because of the optimistic assumptions they made about future economic growth, the pace of recovery, and the ability to expand exports, which made it unlikely that the targets could be met. The political will of the Coalition to carry through the cuts was also uncertain.

Keywords:   financial crash, deficit, fiscal conservatism, coalition

The financial crash of 2008 brought to an end a long period of growth and stability in the British economy, the longest since 1945, and on some reckonings the longest in the previous 200 years. Following the forced exit of sterling from the European Exchange Rate Mechanism (ERM) on “Black Wednesday” in September 1992, the economic outlook looked unfavorable. The economy which had just experienced a long and painful recession, with many home repossessions, a sharp rise in unemployment, and an acceleration of inflation, was just beginning to experience what the Chancellor termed the green shoots of recovery. The ERM crisis forced the Government to announce emergency spending cuts and tax increases. Following immediately upon the dramatic events of Black Wednesday itself when for a few brief hours the Government raised interest rates to 15 percent (up from 10 percent that morning), all trust in the Government’s ability to manage the economy evaporated, and the Conservatives reputation for economic competence plummeted. For the first time for almost twenty years they were less trusted than the Labour opposition to manage the economy, and did not regain that trust until 2008.

Yet paradoxically, the UK economy at the end of 1992 was just about to embark on fifteen years of continuous expansion, which only ended with the financial crash. The Conservatives had presided over booms before, such as Anthony Barber’s dash for growth in 1972 and Nigel Lawson’s expansion between 1983 and 1988. But each had been short-lived and the problems of maintaining economic growth and financial stability had returned. Few would have predicted that the period after 1992 was going to be any different. The reason why first Nigel Lawson and then John Major had been so keen on (p.35) Britain joining the ERM in the 1980s was that it offered the external financial anchor which they thought the British economy so badly needed (Stephens, 1996). The collapse of that policy in a few short hours in September 1992 seemed to leave the British economy dangerously exposed once more. But in fact the outcome proved benign; economic growth was at a modest but still significant rate and was accompanied by financial stability. Securing low unemployment, low inflation, and economic growth simultaneously had been the goal of British governments since 1945, but none had managed to achieve it for more than a few years (Brittan, 1969; Grant, 2002). The fifteen-year success after 1992 was remarkable in the light of previous British economic history (Crafts, 2011), and made the triumphalism which accompanied it, such as Gordon Brown’s boast to have abolished boom and bust, understandable, if in retrospect a trifle unwise.

In part, the UK economy and its governments were lucky. The period of the 1990s and 2000s was a period of substantial upswing in the international economy, powered from a number of sources, including the very rapid growth occurring in the new market economies, particularly China; the impact of the ending of the Cold War; the low price of oil and other commodities; and the increasing success of the financial growth model which had its origins in the United States but for which the United Kingdom economy was highly suited (Glyn, 2006). Yet in the past there had been long periods of sustained boom in the international economy, and the British economy had only partially benefited, being subject to chronic internal weaknesses. In the 1990s and 2000s, there were a series of financial shocks and setbacks. The United Kingdom was caught up in the ERM crisis, but was not seriously affected by either the Asian financial crisis in 1997 or the bursting of the dotcom bubble in 2000. Bubble succeeded bubble but the general movement of the markets continued upward, and sentiment remained on the whole optimistic, although there were some who warned of disaster to come.

Underlying the buoyancy was the complementarity which developed between the export-led growth economies of the rising powers, and the consumption and finance-led growth models of the established powers (Frieden, 2006; Thompson, 2009). A flood of cheap imports kept inflation low, while ever-more ingenious financial innovation developed new forms of credit and ever-more sophisticated financial instruments to finance the purchase of the imports, and to handle the growing imbalances in the international economy which arose as a result. Big asset bubbles developed, particularly in the housing sector in several countries, but while market sentiment stayed optimistic, the dominant view was that the boom would continue, and that the air could be let out of asset bubbles in a gradual and controlled manner without damaging the overall growth of the economy (Greenspan, 2008).

(p.36) This extended period of economic advance and financial stability in the United Kingdom helped embed the market economic reforms of the Thatcher era, while developing policies which were more attuned to social justice and fairness. The combination of economic efficiency and social justice realized under the New Labour Government after 1997 was the culmination of a long search by both Left and Right for a political formula which could unite the two, and provide both legitimacy and prosperity. It helped Labour win three consecutive election victories with substantial parliamentary majorities—the first time Labour had managed to stay in office for more than six years, and govern for more than one full Parliament. A measure of the transformation of British politics which it marked was the reaction of the Conservatives. After their third election defeat, unprecedented in their modern history, they elected David Cameron, a modernizer. Under David Cameron, the Conservatives committed themselves to match the spending commitments which Labour had announced, particularly in areas such as health and overseas aid (Bale, 2010). Just as Labour had been transformed by Thatcherism, so it appeared that the Conservatives were themselves transformed by New Labour. The developing consensus in British politics as to where the center ground was located and the policies needed to appeal to it was shaped by both Right and Left.

The Crash

The events in 2007 and 2008 brought an abrupt change. At first the problem took the form of a credit crunch, the drying up of lending, as banks and financial institutions became increasingly concerned about their balance sheets and the value of their assets. But in 2008 during the dramatic events of September and October, it became a major financial crash, on a scale which recalled the Great Crash of 1929 (Mason, 2009). Governments struggled to contain it, and were force to resort to bailouts, nationalization, and fiscal stimulus, as well as dropping interest rates close to zero. The medicine worked and the financial system did not collapse, as at one stage looked possible. The cost however of the rescue was very high, and the underlying problem that the crash revealed had not been solved, only transferred somewhere else (Gamble, 2009). It also precipitated a major recession, but as in previous financial crises, the recession was not universal. It struck hardest in Europe, North America, and Japan. Many other countries, particularly China, India, Brazil, and Australia, did not suffer recession and were able to continue growing. The check to their expansion was remarkably little considering the scale of the dislocation in financial markets.

This raised the question of how far 2008 was a global crisis rather than a North Atlantic crisis. Was it comparable to those in the 1930s and 1980s, (p.37) which had led to protracted periods of political and economic restructuring of the major capitalist economies? Or was it simply a local financial crisis, even if a particularly severe one, created by asset bubbles in one part of the international economy, and able to be contained there? The question of diagnosis was important because it affected the policy solutions that could be put forward. Did a great deal have to be changed or would some minor adjustments suffice?

In the immediate aftermath of the crash there was considerable reflection and debate on these questions. One issue was whether there had been too much or too little regulation of the banks. Everyone agreed that the banks had played a central role in the crisis, and that it was their lending practices and the way in which some financial institutions had used the new financial instruments which had been developed since the deregulation of the banks in the 1980s which was at the root of the problem. The deregulation was blamed for creating a permissive atmosphere which had encouraged lending practices and a financial culture which were directly implicated in the causes of the crash. The fashionable neoliberal doctrines which had risen to prominence in the 1980s and 1990s and had been proclaimed as the new common sense were seen to be rather threadbare, and many of the economic ideas which were associated with them, such as the efficient markets hypothesis, appeared to have been falsified, or at the very least the models on which they were based required some rectification (Skidelsky, 2009; Eatwell and Milgate, 2011).

A counterargument however suggested that the real failure was not the banks but the regulatory system and the policies which government had adopted to run the economy. The regulatory authorities had failed to restrain the lending practices of the banks, and had failed to spot the systemic risks which bank behavior was creating. The tripartite system of regulation introduced after 1997 diffused responsibility and failed to supervise the system effectively. Furthermore, governments and regulators had often been complicit in the bubble and in promoting the euphoria around it. In many countries, for example, they had relaxed regulation of the housing sector and had encouraged the extension of lending to wider groups in the population. A prime example of this had been the encouragement given by the US Congress to Freddie Mac and Fanny Mae to lend to poor families. These groups were given the loans designated as subprime but it was thought the risks could be so diffused through the financial system that they would not cause a problem. Some other defenders of the financial system go further in arguing that the crisis actually vindicates the efficient markets hypothesis, by showing that there was still too much interference by governments (Pennington, 2011). The markets crashed because there was too much government, not too little.

Some of this debate assumes an answer to a different question. Could the regulators have possessed greater foresight, or does the nature of modern (p.38) markets and financial systems make this impossible? Even if they had had greater awareness that a crisis was impending, there is a further question of whether they would have had the political capacity to do anything about it. The knowledge that was available to policymakers through econometric models was plainly inadequate on its own. They were not able to model the economy in a way which identified the systemic risks it was running. Other models which policymakers could draw on included those from individual thinkers like Hyman Minsky (Minsky, 1982), or historical analysis of the nature of crises in capitalist economies developed by Charles Kindleberger (Kindleberger, 1978). What seems clear is that the available knowledge from whatever source was not utilized, at least not in the phase leading up to the crisis. Some commentators have suggested as a result that the crisis was inevitable, rooted in the forgetfulness of each new generation of politicians and regulators of the lessons learned so painfully from the last crisis. Ben Bernanke was a student of the 1930s Great Depression and the policy errors which led up to it (2000), but it did not make it easier for him to understand before the event the kind of risks that were unfolding. What it did do was to alert him to the dangers once the crash began, and this knowledge of what happened in 1931 helped spur the decisive action which the Federal Reserve and other Central Banks and governments took to avert disaster in 2008.

It has been suggested that the reason why it appears so difficult to anticipate crises and take avoidance action beforehand is because of the widespread belief that develops that “this time is different” (Rinehart and Rogoff, 2008). The perception is correct insofar as every time is different, which means there are always reasons for believing that the crash is not imminent and that the boom still has some way to go. What makes that belief still more plausible are political factors, such as competition between financial jurisdictions, which makes it hard for any single jurisdiction to act unilaterally and impose restrictions on the banks under its control, if the action is not followed universally. Before the 2008 crash there were beliefs held by some of the regulators, notably Alan Greenspan, that as a result of the reforms introduced in the 1980s the economy had really become more resilient. The markets, he argued, possessed a higher intelligence than regulators and could be trusted spontaneously to solve any problem that arose, without the need for regulators to intervene (Greenspan, 2008). That was one theory that did not survive the reality test of October 2008. Greenspan later admitted he had been mistaken, this time at least. No doubt there will be Greenspans in the future who will persuade themselves otherwise.

Other commentators have argued that the bubble could have been contained if the regulators and the politicians had not made some very serious mistakes. Anatole Kaletsky, for example, has argued that Hank Paulson’s decision not to bail out Lehman in September 2008 started the stampede (p.39) which forced the government to intervene and bailout large parts of the banking sector to prevent collapse (McDonald and Robinson, 2009; Kaletsky, 2010; Williams, 2010). If Paulson had taken a different decision, there might have been a much more orderly management of the banks that had become overexposed without requiring the drastic interventionist measures, which have set up problems of their own. Against this view, many observers think that some kind of crash was almost inevitable by September 2008. The system had gone too far to be pulled back.

Aftermath of the Crash

Britain participated fully in the bailouts and all the other measures taken to stabilize the financial system, including quantitative easing, fiscal stimulus, and zero interest rates. These measures did not stop a very sharp recession taking hold in 2009 but they did avoid the risk of it becoming a depression, with a spiral of deflation setting in, as had been the case in the United States after 1929. What this response did, however, was to create very large public sector deficits, which swelled even larger, both absolutely and as a proportion of GDP, once the recession took hold. The tax base shrank and the number of claimants began to rise. During the course of 2009, the way the crisis had been dealt with ended the banking crisis, but did so primarily by transforming it into a sovereign debt crisis.

The Labour Government at first attracted some support for its leadership in the financial crisis. Gordon Brown was prominent in pressing the case for concerted international action to shore up the financial system, and prevent something much worse from occurring. But this was soon eclipsed by the dawning realization of the size of the debt Britain had incurred in bailing out the banks, and by the gloomy economic prospect created by the recession and the austerity that would be required to keep the deficit under control and eventually pay it down. The contrast with the previous fifteen years of increasing prosperity and financial stability was sharp, and the Conservative Opposition moved quickly to exploit the position and emphasize its differences with the Government.

The Conservatives, as soon as the crash happened, opposed the extent of the bailouts of the banks which the Government implemented. They were not opposed to all interventionist measures, and many suspected that in Government they would have followed the same path, but they did strongly object to the open-ended nature of the help that was being offered to the banks. The Conservatives chose to stress the need for fiscal responsibility, and for the banks to shoulder their responsibility for the mess they had created. This developed over the next eighteen months in the run-up to the general election (p.40) in 2010 as a distinct difference between the Conservatives who wanted the deficit to be contained, and a plan introduced for reducing it much more quickly than the Government thought was sensible. All parties agreed that the deficit would need to be reduced in the medium term, but ahead of the general election none of them was willing to give much detail on how that should be done.

The Conservatives also began to develop what was to become a very effective line of attack upon Labour—the argument that the state of the public finances was Labour’s fault and a result of its stewardship of the economy over the previous ten years. It had not mended the roof while the sun was shining in George Osborne’s words, but had actually continued to spend above trend, leading to a growing gap in the public finances which was funded by increasing borrowing. This meant, according to the Conservatives, that Labour had already created a structural deficit in the public finances before the financial crash. It was spending more in its current consumption than it was raising in taxes and was having to resort to additional borrowing as a result to cover the shortfall. The Conservatives claimed that the public finances were out of control, and that when the financial hurricane hit, Labour was not only ill prepared but made the situation much worse by going overboard in its pledges to the banks and in the size of its fiscal stimulus, which had the effect of swelling the deficit to dangerous proportions.

This account was strongly contested by Labour and by some economists, who pointed out the technical difficulties of deciding when a deficit is structural, and when it is just a deficit which arises quite normally and can be managed without difficulty. The Treasury was partly at fault in appearing to confuse a cyclical increase in tax revenues with a structural increase. But beyond this dispute about the structural deficit, there was a more profound disagreement about the right policy stance in a financial crash and the subsequent recession. Labour accused the Conservatives of using the crisis as an excuse to roll back the state for ideological reasons, although they have struggled so far to make the charge stick. In 1930 and 1931, the two sides in this debate were forcibly represented by two leading economists, John Maynard Keynes and Friedrich Hayek, and there are echoes of both positions today (Skidelsky, 1967; Skidelsky, 1992; Clarke, 2010). The Hayekian argument was that fiscal deficits are a barrier to recovery and should be removed as quickly as possible, whereas the Keynesian argument was that in a recession government should run deficits to facilitate the quickest possible recovery. In practice, this can amount to no more than a difference of emphasis, although still a significant one in terms of policy choices. In 1930 and 1931, the consequences of a form of Hayekian reasoning being dominant in the US Treasury led to the severe deflation, when prices and wages dropped by one-third and unemployment rose to 20 percent (Galbraith, 1955).

(p.41) In Britain in 2009–10, the argument centered on timing. Over what period should the budget deficit be eliminated? Should it be over the lifetime of one Parliament or longer? Labour wanted longer, and they proposed not to start to cut the deficit until there were clear signs that the recovery was under way and well established. The Conservatives argued that restoring financial stability and the confidence of the bond markets in the Government’s intentions could not wait. They wanted the deficit to be eliminated entirely in the space of a single Parliament (five years).

What was noticeable in the debate as some commentators pointed out was that no party was prepared to advocate a thorough-going Keynesian approach to the deficit, which would have been to make no plans to cut the deficit at all until the recovery was firmly established. Keynes had dismissed the doctrine at the heart of the Treasury view, the idea that public spending crowds out private spending. Hayekians argued that it always did so, Keynesians that it only did so when there was full employment of resources. It was a measure of how powerful the discourse of fiscal responsibility still remained in British politics that as in 1931 few mainstream politicians were prepared to put the Keynesian case.

The Coalition Government’s Deficit Reduction Plan

The result of the 2010 UK General Election was indecisive as the polls had predicted. The Conservatives won the most seats (306) but fell short of an overall majority (326). Despite a sharp drop in its share of the vote, the Labour party’s share of seats (258) was protected by the electoral system. The Liberal Democrats won fifty-seven seats and other parties twenty-nine. It was widely expected that the Conservatives would seek to form a minority administration, on a confidence and supply basis, and hold a further general election as soon as possible in the hope of winning a majority. David Cameron on the morning after the election invited the Liberal Democrats to discuss the formation of a full coalition Government, with Liberal Democratic Ministers in the Cabinet, and after a frenzied weekend of negotiation this was agreed, with Nick Clegg, the Leader of the Liberal Democrats, becoming Deputy Prime Minister.

This was the first formal coalition in peacetime between two major parties since universal suffrage. The National Government of 1931 had members from all three main parties, but did not have the official endorsement of either Labour or the Liberals. But the reason why David Cameron made the offer of a coalition in 2010 was not dissimilar from the reason that Stanley Baldwin agreed to serve in a National Government led by Ramsay Macdonald. It meant the Government could be presented not as a partisan Tory Government but as a government formed in the national interest to deal with the economic (p.42) situation. During the election campaign, the Liberal Democrats had been much closer to Labour in their analysis of the deficit and the timescale over which it should be reduced. Detaching the Liberal Democrats as part of a center-left opposition to the Conservatives, and getting them to support the deficit reduction program which the Conservatives wanted to introduce from the government benches, was a great potential political benefit. Some Liberal Democrats were surprised during the negotiations which resulted in the formal Coalition agreement at the readiness of the Conservative negotiators to accommodate so much of the Liberal Democrat manifesto, and put it down to the inexperience of the Conservatives at Coalition negotiations. But the Conservatives were careful to keep their red lines on the economy, defense, and Europe, and were quite happy to make concessions for the greater strategic prize of having the Liberal Democrats inside the tent and defending deficit reduction and blaming Labour for the mess they had inherited (Quinn et al., 2011).

The Coalition lost no time in announcing its plans for dealing with the deficit. George Osborne delivered an Emergency Budget in June 2010, which, apart from some immediate spending cuts, also laid out the Government’s intentions, in particular its plan to eliminate the budget deficit in one Parliament. It also established the Office for Budget Responsibility to provide independent forecasts and audit of the Government’s fiscal plans. This continues and has extended the trend of recent governments to seek to depoliticize key parts of economic policy (Burnham, 2001). It was followed by a Comprehensive Spending Review over the summer which reported in the autumn and laid out in detail the Government’s plans for fiscal reductions.

From the start, the Government was very concerned with how to present its deficit reduction plan. It was determined to win the political argument that the deficit was largely Labour’s fault, and showed once again that Labour could not be trusted to manage the economy. The severity of the cuts that were necessary to eliminate the deficit, Osborne argued, were not because the Coalition wanted to cut for its own sake, but because Labour’s profligacy in spending and incompetence in regulation of the financial system had made these cuts inevitable. The Government’s propaganda offensive was carefully choreographed, with every Minister required in every interview on whatever subject to mention the “mess” inherited from Labour, and how the Coalition Government was acting in the national interest to clear it up. In 1931, the National Government had claimed a doctor’s mandate to deal with the financial crisis. The Coalition Government in 2010 retrospectively claimed something similar.

A second argument which was deployed to great effect, particularly by Liberal Democrat Ministers explaining why they had changed the policy on which they had campaigned in the General Election, was that the external situation had suddenly worsened because of the spread of the problems in the eurozone to Ireland. Ministers argued that if Britain did not take decisive (p.43) action to reassure bondholders that it had a credible deficit reduction plan, the credit agencies might downgrade UK’s credit rating, and Britain could end up having to apply to the IMF for a bailout. There was no firm evidence for this view, indeed considerable evidence to the contrary, notably the long-dated bonds which the markets were happy to subscribe, indicating that there was confidence in the markets in the ability of the UK Government to service its debt because the composition of the debt was mainly long-term. There was certainly no immediate problem in May and June 2010. But the idea that Britain faced its own sovereign debt crisis that summer, and that it was only defused by tough and resolute action by the incoming Government was a narrative too good to miss, and it was duly deployed on every possible occasion.

The Government benefited from the understandable confusion in the public mind between the debt and the deficit. The figures for the overall national debt sounded alarming, until put in the context of the national debt of other countries, and in the context of Britain’s national debt in the past (250 percent after the Napoleonic Wars and again after World War II). In 2010, it was a rather modest 60 percent of GDP forecast to peak at 79 percent in 2014. On the budget deficit, the numbers were large, but a large part was cyclical, and the amount that was genuinely structural was disputed. However, it was clear that unless the Government wanted Government spending to consume permanently a larger share of GDP, it needed to reduce public spending at least in line with the reduction in GDP caused by the recession (6 percent in 2009) (Wolf, 2011).

This still translated into large cuts. The deficit reduction plan was more stringent than the one which had been set out by the last Labour Chancellor, Alastair Darling, but not by much. The Comprehensive Spending Review suggested that cuts would be needed of between 20 and 25 percent in most departments, and up to 40 percent in others. Some programs, in particular health and foreign aid, would be protected, and others like defense, partially protected. These headline figures however were slightly misleading because the cuts were to be spread over four years, and the Government’s own red book showed that public spending in real terms would continue to increase over the period of the Parliament, while falling back as a percentage of GDP from 45/47 percent in 2009/10 to 40/41 percent in 2014/15. If achieved, this would be the same level as 2007 (Office for Budget Responsibility, 2011).

This deficit reduction plan, as many critics pointed out, was heavily dependent on assumptions about growth and in particular about export growth which were considered heroic and very unlikely to be achieved, since they were considerably higher than had been achieved in any previous postwar recovery, and were obviously very vulnerable to external shocks and what was happening in other countries. If the growth targets could not be met and the rebalancing of the economy away from the public sector to the private sector was not achieved on a scale sufficient to deliver the expanding tax base on (p.44) which the plans depended, then something else would have to take the strain. Since the Government would not wish to raise taxes as the election approached, the most likely consequence if the fiscal targets began to be missed would be an acceleration of inflation.

The UK experience in 2010/11 confirms that decisions which governments take on the scale and scope of the public sector are generally more significant than external pressures. The IMF crisis in the United Kingdom in 1976 has entered into British political mythology as the time when the British Chancellor of the Exchequer, Denis Healey, was forced to go “cap in hand” to the IMF to secure a loan to prevent the continuing fall of sterling on the foreign exchanges. The condition of the loan was that the Government push through major spending cuts, on which the Cabinet could not agree. This episode is regularly cited as an example of how the markets constrain the choices of democratically elected governments, but the truth is rather different. Initial analysis by Steve Ludlam (Ludlam, 1992) has now been confirmed by work in recently available archives by Chris Rogers, showing that much of the IMF package was suggested to the IMF by the British Treasury and Treasury Ministers. The IMF was used as a convenient cloak for policies which a significant part of the British Government wished to pursue independently. Invoking the IMF helped resolve the deadlock within the British Cabinet (Rogers, 2010).

The position appears even more clear cut in 2011. The austerity program on which the Government has embarked reflects certain deep-seated choices about the appropriate scale and scope of the public sector in Britain. The history of public spending in Britain since 1945 shows it passing through regular cycles. The bias is for expansion, and this is interrupted by periodic bouts of cuts. These slow the upward rise of spending but they do not reverse it, and so far no postwar government has been successful in shrinking the state, moving the state back to a much lower level of activity. On the other hand, governments find cuts packages and the atmosphere of crisis which surrounds them extremely useful as a means of restraining the pressures for ever greater spending. These pressures arise both from the cost of providing public services and the demand for them in competitive democracies, as well as changing demography.

The Coalition has been insistent from the beginning that it wants to cut spending more than it wants to raise taxes to bring down the deficit. George Osborne has suggested that the total cuts package aims at reductions in spending of 78 percent and increases in taxes of 22 percent. These figures are somewhat misleading because some of the cuts in spending, such as the cuts to university budgets, will be experienced by citizens as in effect increases in taxes, through the increase in tuition fees. One of the problems for governments is that while tax increases are generally unpopular, they are often easier to achieve than cuts in spending. This is because spending cuts are easy to announce but hard to implement. Many of those needed to implement them (p.45) may be unwilling to do so, and may obstruct or hold up the implementation in various ways. Public spending cuts, such as the closure of libraries, often have a direct impact on particular groups who mobilize to resist them. The benefit that other citizens enjoy from having an overall reduction in spending is much more widely diffused.

The Coalition like many governments before it has used the language of fiscal consolidation to make great play of the productive private sector and the unproductive public sector. Only the former is considered to be wealth creating. This has always been a staple of the Treasury view. But it is a serious misconception as numerous social scientists have pointed out. There is a powerful symbiosis between the public and private sectors, so that neither could exist for long without the other. Much of the public sector is actively involved in supporting and sustaining wealth creation; that is the reason why it has expanded so much. The Coalition Government has demonstrated the truth of this by pressing ahead with plans for high-speed rail links, despite the severity of the cuts and considerable opposition from Conservative MPs whose constituents are affected. Modern states are intimately involved in fostering the conditions under which the long-term health of the economy can be assured, and this requires major investment in infrastructure, in the science base, as well as more generally in health and education. In the circumstances of contemporary politics, these are never simply private consumption goods.

Progress on achieving the deficit reduction program has so far been mixed. The Government has suffered significant reverses, sometimes on relatively small matters such as selling off state-owned forests, sometimes on much bigger issues such as reorganization of the National Health Service. Health has not been targeted for reductions, although efficiency savings are being applied. Ministers are aware that just to keep the health budget constant they need to find major economies over the next few years. Since it is the largest spending program, any small failure could lead to major spending overruns. The climbdown the Coalition was forced to announce in 2011 is likely to make the containment of cost pressures in the NHS much harder. The Government in its first year acquired a reputation for backing down if sufficient pressure was exerted, and this pressure is likely to intensify as the cuts start to bite over the next two years. The area where the Government seems least likely to back down however is local government, even though at the moment most councils are controlled by the Conservatives. It is council services of all kinds which are likely to feel the toughest squeeze, in part because Ministers can distance themselves from the decisions and blame them on local councils. Even here, however, the Government has shown it is not immune to pressure. It has backed down on its demand that waste bins should be emptied once a week, once it became clear of the additional expenditure that would be required to achieve it, and it also appears to be retreating on recycling schemes.

(p.46) The Debate on Growth

The triumph of fiscal conservatism in the United Kingdom after 2010 followed a well-worn pattern. The ground was prepared by the Labour administration, and in the end there was surprisingly little resistance. It became a debate about timing and scale rather than a serious debate about alternatives. One cloud did hang over the discussions, however. The period of growth and stability had been based on a particular growth model, a financial growth model, which had brought significant success to the British economy. It reflected a particular kind of political economy, both in doctrines and in institutions and policy, often dubbed Anglo-Saxon capitalism, but in the aftermath of the crash this model appeared shattered beyond repair. There was briefly talk that neoliberalism had been discredited by the crash, that Keynes and Keynesianism had been rehabilitated, and that nothing would ever be the same again.

Neoliberalism, however, has showed much more resilience than some expected, and has crept back so that three years after the crash you could be forgiven for thinking that it had never been away. Bankers began receiving bonuses again and all the talk became of restoring the structures and the links which had been sundered in 2008. There has been considerable discussion of reform to international financial institutions and to domestic regulatory systems, but so far little action. The rhetoric is still “Never Again,” and there is much talk about the need to rebalance the economy, one aspect of which is to stop relying on the financial services quite so much. But this runs up against the problem in the United Kingdom that for the previous twenty years, financial services has been a leading sector, and one of the major sources of jobs and taxes and exports for the UK economy. If the consequence of fiscal conservatism is to push the City off its pedestal and hedge its operations around with restrictions, then some other source of growth has to be found, especially since the medicine prescribed by fiscal conservatism will only work if there is robust growth in the economy. Only that can make the burden of austerity tolerable by expanding the tax base and making the burden of debt easier to carry.

British policymakers are aware of the importance of growth for the success of their stabilization plan, and indeed fiscal conservatism contains an implicit growth model, which is the laissez-faire model of nineteenth-century liberalism, memorably articulated in recent times by Nigel Lawson (Lawson, 1992). It assumes that fiscal contraction will clear the way for new growth to emerge spontaneously in the private sector. In the old formulation, if prices fell far enough and fast enough, all artificial values would be wiped out, and only true values would be preserved. These would form the basis of the recovery, which would restore profits and with them employment. The economy is diverse (p.47) enough and flexible enough to generate new activities, new demands, and new markets. Two obvious objections are that in the context of the contemporary economy countries like Britain have not followed the prescriptions of fiscal conservatism and allowed their banks and a large proportion of their industries to fail; instead, they have bailed them out. Secondly, the main prospect for growth depends on what happens elsewhere in the global economy, and in particular what happens to the rising powers. The assumption in liberal political economy has always been that the entry of new countries into the global market is a positive-sum game. They have remained optimistic, contrasting with those who take a more mercantilist perspective, believing that the next phase of the global economy will see a redistribution toward the rising powers. This is bound to be so in relative terms; the question is whether it might also be so in absolute terms.

The optimistic scenario for the fiscal consolidation under way is that any check to the growth of income and wealth proves temporary; the UK economy is able to adjust and a strong recovery becomes established. This hope has been voiced by previous Conservative Chancellors including Norman Lamont and Nigel Lawson. During the first six months the signs were mixed, with some employment growth, but also continuing sluggishness in consumer demand which depressed output figures. Given the uncertainties in the international economy and the weaknesses in the UK economy which the crash once more exposed, nobody is expecting a very fast recovery, but a slow modest recovery would probably be sufficient for the Government’s needs and would be taken as vindicating their strategy on the deficit. The opposition has called for a Plan B, arguing that George Osborne’s Plan A is not working. They want the cuts to be phased in over a longer period, and more attention given to nurturing the recovery. Many commentators think that the Government’s course is risky.

The optimistic scenario may be justified however, partly because the fiscal consolidation is not as fierce or as inflexible as both its supporters and its critics sometimes make it appear. There are many ways in which its impact can be changed without the Government announcing that it has moved to a Plan B, which would represent a major political defeat. The Government is able still to make full use of the Keynesian automatic stabilizers, and its numerous retreats on many specific cuts mean that the overall effect of its cutbacks may prove less drastic than supposed. If the outcomes diverge too much from the plans this may be pointed out by the Office for Budget Responsibility, which would be embarrassing, but the Government would survive and no doubt plead external circumstances in mitigation. If it is in a position to deliver tax cuts ahead of the next election, and paint a more optimistic future, voters are likely to be forgiving.

(p.48) Critics on the right worry that the Government is not doing enough to make this optimistic scenario come true. They see the backsliding and fear that the Government does not have enough political will to impose the level of austerity needed to wipe out the artificial values of the old boom and the toxic debts and create the conditions for a new boom. They suspect that the Government is too half-hearted and may end up presiding over a slow recovery and slow growth, which will narrow its choices. The still more pessimistic scenario is that the Government finds it very hard either to revive the old growth model or to develop a new one. This is because the crash has exposed the strategic weaknesses of the UK economy, particularly the underinvestment in skills, the small size of manufacturing, and the continuing dominance of financial services. The most pessimistic critics think that another crash is possible or at least a long period of stagnation.

The big question for the next stage of development of the British economy is whether the experience of the last twenty years has given the economy a new resilience and flexibility which will allow it to develop in new and perhaps unexpected ways in the next decade, or whether the long-term structural weaknesses are about to reassert themselves, leading to an uneven recovery with marked North–South differences. There is a significant policy disagreement here, since the first diagnosis would suggest that cutting taxes, rebalancing the economy by reducing the public sector, and promoting both deregulation and free trade will do the trick. The second diagnosis suggests that what is needed is strategic investment in skills, technologies, and infrastructure, with protection for particular spheres of development, and the search for new sectors such as green industries which can provide the basis for a new growth model (NEF, 2008). Many are skeptical. All these strategies make assumptions about the continuing openness of the British economy to the international economy, and whether the liberal world order can be sustained through deals between its most significant players, particularly China and the United States. More close to home the British have to worry about the eurozone, the market which takes so much of British exports, and what its future is going to be. The fiscal consolidation in Britain is still in its early stages, and it is too soon to say how successful it will be either in securing its immediate objectives or in contributing to a broader economic recovery. But it has already confirmed certain deep-rooted features of the British political economy.


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