Social and Economic Austerity

There is a great deal of discussion, following the election, of relaxing or even abandoning austerity. There is an equal amount of confusion about this. Because the same word is being used to describe two quite separate concepts. The consequences of the government changing its policy on austerity are dramatically different, depending on which one it is.

One meaning of the word is what we might call “social austerity”. From any given pot of money available to a government, its supporters believe that, in general, tax cuts should be promoted rather than public spending increased. Opponents argue that public spending as a result has become underfunded. Local councils, education, the NHS, all need more money.

Social austerity can be relieved, as even the DUP and some Conservatives argue, by increasing spending appropriately, and funding it by increases in taxation. This was an important aspect of Labour’s manifesto. The tragedy at Grenfell Tower has intensified the discussion around it.

The main risk is purely political. Are voters really and truly willing to pay more tax, rather than just wanting someone else to pay it?

There are some potential adverse economic consequences if the policy of higher taxation is pushed too far. Ex-President Hollande’s 75 per cent tax rate in France led to several hundred thousand skilled young people leaving France, mainly for the UK. If companies are taxed too heavily, they may choose to locate in another country. Both skilled labour and capital are geographically mobile.

But, within reason, social austerity could be relaxed without perhaps too many fears in this direction.

“Economic austerity” is quite a different matter. Opponents of this want to increase the gap between government spending and tax receipts, the so-called fiscal deficit. This is funded by issuing government bonds. So both the deficit in any given year goes up, and the outstanding stock of government debt also rises.

Any relaxation of social austerity is paid for by higher taxes now. Any relaxation of economic austerity is paid for by borrowing more now. But the debt has to be repaid at some point, and the interest payments on it must be met. So taxes in the future will be higher. Either way, less austerity means more tax.

Keynes himself made it very clear that increasing public spending at a time of full employment would simply lead to more inflation.

There are bits of the country where there probably are people registered as unemployed who genuinely do want to work. The Welsh Valleys, for example. But the rest of the UK is at full employment.

The number of people in employment is at an all time high, at 32 million. This has risen by 2.8 million since 2010. The unemployment rate has fallen from 7.9 per cent in 2010 to just 4.6 per cent now.

Any major fiscal stimulus to the economy now would simply bid up wages, leading to higher costs and higher inflation.

The public mood on social austerity may have shifted. But the case for economic austerity is stronger than it has ever been.