An economics lesson for Matt Hancock

Matt Hancock MP today sets out the Government's case for its accelerated spending cuts programme. His article owes more to politics than economics.

New Tory MP and former chief of staff to George Osborne, Matt Hancock, today takes to the pages of The Times to set out the Government’s case for its accelerated spending cuts programme. Hancock is an economist by training and worked for the Bank of England. Sadly, he’s let politics get in the way of the economics.

After a preamble, Hancock’s argument begins by examining market confidence in the Goverment’s policy:

Dealing with a debt problem boosts confidence that the economy will be stable. Interest rates can be kept lower for longer as the Bank of England supports demand. International investors ask less of a premium on the money they lend.

This is happening. Market interest rates have fallen. This week the rating agency Moody’s said that the UK’s AAA credit rating is safe because of the Government’s action. Interest rates for government borrowing for two or three years have halved since the election. Lower interest rates both save money and stimulate the economy. I grew up in a family that ran a small business, so I know just how much businesses benefit from lower interest rates. Homeowners benefit from lower mortgage rates, which matters even more since household debts are the highest in our history.

The problem for Hancock is that the yield on 10-year gilts was falling while Labour was still in office and this decline has had very little impact on mortgage rates or bank lending. In any case, this needn’t be seen as a sign of confidence in either Darling or Osborne. US rates have also fallen over the same period. Markets are effectively downgrading the likely date of the Bank rising its base rates due to  sluggish growth. Indeed, Moody’s statement earlier this week was clear that “slower economic growth” could jeopardise the rating.

Hancock goes on to look at how badly the cuts could hurt the economy:

I discovered that research into dozens of past fiscal tightenings shows that, more often than not, growth doesn’t fall but accelerates.

A study in 2003 by the European Commission found that of 74 consolidations examined, in 43 cases growth accelerated. In the mid-1980s, Spain, Portugal, Denmark and Ireland all had to rein in large deficits and their economies grew as a result. Finland, Sweden and Italy found the same in the mid-1990s. After the large cuts made by Canada in the 1990s, its economy then grew. More recently, after tackling its deficit, Sweden is growing at more than 4 per cent.

Again, the Tory MP is selective with the evidence. None of these consolidations took place on the back of what has been the world’s worst recession since the 1930s. In almost all of the scenarios he cites, growth was able to bounce back because global demand was buoyant, exchange rate depreciation caused export-led growth, and there was room for large falls in interest rates. None are possible or happening in this instance. The Bank of England – alongside many independent analystscut back its growth forecast in August citing the planned deficit reduction measures as one of the factors. In any case the study cited by Hancock only provides a 58 per cent success rate and correlation does not equal causation.

Next, Hancock claims there’s no need for a Plan B if the Chancellor’s “gamble” turns out to be wrong:

Evidence from the past also indicates how we can get this positive result. First, cuts are most likely to lead to growth where a credible plan is set out and kept to. Where countries give up on a programme of cuts halfway through, confidence is undermined and growth is harmed…

Some people who oppose the cuts keep asking: what is Plan B? But would you go into a marriage talking about Plan B? Who gets down on one knee and says: “Darling, let’s talk about what happens if this doesn’t work out”? Like a marriage, the surest way to end up on Plan B is to start talking about it.

So how does Hancock explain the Irish experience? Despite their cut, cut and cut again agenda, the markets are still not convinced by the Irish policy as Duncan Weldon expertly showed this week. Indeed, as the Irish economy has slumped, tax revenues have fallen from €47bn in 2007 to €31 billion this year. Indeed, Hancock’s marriage analogy is even more banal than Clegg’s household debt metaphor earlier this week.

Hancock’s next justification is of the 4:1 ratio of spending cuts to tax rises:

The second lesson from the research is that consolidation helps growth when it’s mostly done through spending cuts, not tax rises. The OECD say the best balance for growth is 80 per cent cuts and 20 per cent tax rises. If government is living beyond its means, growth can only come from private businesses; tax rises that discourage enterprise would harm any prospect of boosting that private sector growth. What type of spending is cut matters too. Maintaining capital spending and minimising public sector job losses by restraining pay and tackling welfare spending helps growth.

Why then does the OBR (Table C8 of the Budget) say that spending carries twice the multiplier of taxes? Spending cuts are also a much better way of guaranteeing unemployment since they directly affect public sector and contractors’ jobs.

Finally, Hancock tries to underplay the scale of the cuts to come.

But if the hole is so much bigger won’t the cuts hit more? I looked at the numbers. GDP grew by 1.2 per cent in the last quarter. By contrast the extra £6 billion cuts this year announced by the coalition amount to 0.1 per cent of GDP per quarter. Over the next five years, the scale of the extra cuts is the same. Compare that with the huge boost from showing the world we have got to grips with our finances. After all, the size of the State and the size of the economy are not the same thing.

On this point, Hancock’s grasp of the facts exits stage far-right. £6 billion of spending cuts this year will be followed by £23 billion next year rising to £83 billion by the end of the Parliament – nearly 14 times the pain already experienced.

Hancock ends by claiming, “The evidence is clear: we can keep growth going and sort out our finances — so long as we stick to the plan.” His evidence owes more to wishful thinking than any real grasp of the dismal science.

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56 Responses to “An economics lesson for Matt Hancock”

  1. fljf

    RT @leftfootfwd: An economics lesson for Matt Hancock – fisk of his Times article

  2. yorkierosie

    RT @leftfootfwd: An economics lesson for Matt Hancock

  3. idle pen pusher

    StephenH – first graph is very dodgy, start from when the recovery started (in Germany first, not US) and it looks very different. Second one I looks like it ignores transfer payments. Why? That money counts, too. Giving cash to people in exchange for being unemployed or having children is no less a fiscal stimulant than giving them cash for writing reports about diversity.

    Mr sensivle – Government spending can only increase equilibrium unemployment rates. The more it spends, the more unemployment there will be (once the economy has adjusted to that spending). And vice versa. Sure, if you fire people they’ll mostly be unemployed a while till they get a new job, which will increase unemployment during that time. But once they’ve all got jobs, total unemployment will be lower. I’ve explained why here

  4. Mr. Sensible

    IPP I just think you’re plain wrong.

    The OBR itself talked about 600000 job losses across the public sector, and a leaked Treasury slide reported in the Guardian in July expected 700000 jobs going in the private sector due to lost public sector work, as well as presumably less spending power by those already out of work causing a continuum.

    I believe that a few months ago the CIPD suggested that unemployment could stay close to 3 million for all of this parliament.

  5. idle pen pusher

    Mr Sensible – imagine what would happen if we weren’t to cut. Firstly, confidence in the government would fall. People would begin to wonder whether the government would start printing money to pay the bills or whether it would simply keep on borrowing £150bn/year. Neither would be pretty. Interest bills would soar and we’d find ourselves in a Greek mess in short order. Would we slash back public spending then, or hike taxes? Or just default on the debts? What do you think all that would do to unemployment?

    And think about those companies that went bust because taxes were higher. If we didn’t raise taxes then we’d have to borrow the money, which would mean less finance for business, because lenders would be lending their capital to the government instead. That means unemployment and bankruptcies. Or perhaps you’d just print more money and let inflation run riot?

    But if we do cut spending then people are not going to be worried about the government defaulting on their loans so they’ll lend more cheaply to the government. There will be more capital available for private borrowers. People won’t fear runaway inflation.

    You need to think beyond the immediate effect of firing a public sector employee and think what effect lower taxes and less crowding out in the capital markets has on employment and growth. As Blair has said, it’s private enterprise that will provide the jobs and the growth to get us out of the current situation, not the state.

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