Austerity 2.0 is Another Con Job. Don’t Fall for It
The 'black hole' in the public finances is a myth.
by James Meadway
31 October 2022
With new prime minister Rishi Sunak installed, the rapid u-turn on former chancellor Kwasi Kwarteng’s disastrous mini-budget at the end of September is almost complete.
He and chancellor Jeremy Hunt are threatening a fresh round of austerity, with Hunt promising “eye-watering” cuts at future “fiscal event”. Originally scheduled for 31 October, this has now been moved to 17 November. But whatever announcements are finally made in mid-November, austerity remains a political choice to favour the rich over the rest, and must be opposed. The so-called “black hole” in the public finances is an accounting device, not a real loss of money. No one, including the leadership of the Labour party, should be fooled by it.
The delay to the announcement is likely to be the result of significant horse-trading and political bickering behind the scenes at the top of government. The deal Sunak has evidently done with the Tory right – inviting hardliner Suella Braverman back into the cabinet just six days after her sacking for security breaches – has most likely made the balancing act harder.
The Office for Budget Responsibility’s model generates higher growth forecasts when expected net migration is higher; inviting Braverman back as home secretary implies future migration is likely to be lower, damaging forecasts. Lower projected growth, in the topsy-turvy world of the Treasury, means more future cuts. More cuts means more of a headache for a weak prime minister.
Why do all this? For the same fundamental reasons as George Osborne: Britain’s state managers view the priorities of its financial sector as paramount. To maintain a large and globally-exposed financial system in Britain means having a government always ready to bail it out when it crashes – as it is always at risk of doing so. That, in turn, means having a government that isn’t carrying a large debt or a significant deficit, in case of future crashes. The overall result is an economy that works less well than it ought to for most of us – but Britain’s role as money-dealer to the world is secured. Sunak is a former investment banker; Hunt, lacking the direct experience, has appointed an “economic advisory council” drawn exclusively from financial services, including Osborne’s former advisor, Rupert Harrison.
The critical problem for the government this time around is that whilst in the 2010s inflation was at its lowest levels for a century – even turning negative for a while – that obviously no longer applies. Everything is becoming more expensive, from the gas we depend on to keep our homes warm to the food we eat. That, in turn, means that government budgets set a few years ago for a relatively low-inflation time are now looking squeezed, even before actual cuts.
That price squeeze is one of the factors dragging us into recession, as ordinary people, forced to spend more and more on essentials, cut their spending on other goods and services. Plans by the government to also cut its spending reinforce this impact on demand. The spectre of “stagflation” beckons as a result: the deadly combination of stagnation, meaning recession, and inflation, meaning high prices.
In theory, the Bank of England is supposed to work to keep inflation low. In practice, it is worse than useless. With headline inflation at more than 10%, rising back into double figures as a result of very high food price rises, the Bank’s monetary policy committee, which sets the Bank’s interest rate, will no doubt take the opportunity at its monthly meeting this week to push rates up further. It will also be spurred on by the US central bank, the Federal Reserve, remorselessly pushing up its own interest rate. That, in turn, is leading to a rush of capital into the US and, as the dollar rises in value on the back of this, a steady slide in the value of other currencies in comparison. As the pound falls in value, imports into Britain become more expensive – feeding into inflation.
The Bank of England believes that higher interest rates will help induce a recession, and that higher unemployment will frighten workers into moderating their demands for higher wages. That, in turn, is supposed to bring inflation down. Never mind that wages are not causing inflation – regular pay is currently rising at 5.4% in Britain, well behind inflation. Inflation in Britain today is the result of rising prices across the rest of the world – even as international gas prices have (temporarily!) come down, food prices are rising at record rates.
This situation is unlikely to change any time soon. The Sunday Times has reported that the cabinet had been briefed that gas prices are likely to remain high for the rest of this decade. Harvests next year, buffeted by fertiliser shortages, extreme weather events, and the remorseless march of climate change, are expected to be poor – and the situation is unlikely to improve. Interest rate rises will do nothing to grow more grain or pump more methane, but might well worsen the recession we are headed towards.
This gets us back to austerity. Recognising the deep unpopularity of spending cuts, the Tories are today fudging the question. Undoubtedly there is a section of their own parliamentary party, and wider membership, that is ideologically committed to the principle of a smaller state. But the people now running the party – the pro-City faction around Sunak and Hunt – are bureaucrats more than ideologues. They know, because it has become unavoidable, that the core functions of a modern state have been whittled away by austerity: the NHS is creaking painfully, our school buildings so dilapidated that some are a “risk to life”, even simple things like weekly bin collections have become a thing of the past across much of the country.
An attempted radical solution to the multiple crises of Britain in 2022, that of Truss and Kwarteng, was rapidly – and deliberately – derailed. The steady management of decline is now the order of the day in Whitehall. Future austerity measures will be calibrated by the political need to sneak them past a broader population, certainly including all those new Tory voters in so-called ‘red wall’ seats, who have lost all patience with spending cuts and were promised in 2019 that no more would be necessary.
In practice, this means austerity 2.0 is likely to play out differently to the carnage of the Osborne years. Bloomberg and others report that Hunt is looking at 50:50 division between spending cuts and tax rises in his deficit reduction plan. Osborne, by contrast, went for a roughly 80:20 spending cuts to tax rises ratio – worsening the social impact of the programme significantly.
Reports suggest Hunt is scrabbling around for tax rises, with an expansion of the existing windfall tax scheme, changes to capital gains tax and a “bank tax” all reportedly under consideration. The National Insurance Contribution increase, recently scrapped by Truss and Kwarteng, may be reintroduced – hitting millions of workers. Meanwhile, slashing capital spending – in other words, spending on buildings, or new equipment like railways – is bad for the long term, but not much noticed immediately.
Crucially, hints in the press suggest that Hunt will be aiming to park most of the cuts until after the next election, legally due no later than January 2025. This would allow him to claim that the so-called “black hole” is being filled, whilst shoving any political pain onto whoever wins the election: either the Tories, who could then claim a mandate to implement cuts, or a Labour-led government, who would then be left with the political problem.
But the so-called “black hole” in the public finances is not real, in the sense that the government suddenly has less money. It is calculated from looking at forecasts for economic growth, and the government’s own target for debt reduction. Change the forecasts, or change the debt reduction target, and the “black hole” magically shrinks. Already in the last few weeks it has been reduced by £10bn or so as a result of better forecasts for future interest rates. Changing the debt target could shrink it further. But talking up the “black hole” today is useful expectations management for the government – softening us up to expect the worst, and then claiming the plaudits when austerity isn’t as bad as expected.
No one should fall for tricks like this. Austerity is a choice, not an economic necessity – a choice, fundamentally, to prioritise big finance over the rest of the economy. Changing or ditching the debt target, and taxing the rich, would allow our public services to be properly funded. We cannot suffer another decade like the last: austerity must be resisted.
James Meadway is an economist and Novara Media columnist.