Home Political science A Century of Fiscal Squeeze Politics : 100 Years of Austerity, Politics, and Bureaucracy in Britain
The Road to 2010
This squeeze followed a deep international financial crisis over bad loans, triggered by the sudden and unexpected collapse of a major US bank (Lehman Brothers) in 2008, but preceded a year earlier by the collapse, rescue, and nationalization of a small UK bank, Northern Rock. The 2008 crisis led the then UK Labour Government to mount what is said to have been the biggest bank bailout in history in rescuing the Royal Bank of Scotland and two other large British banks (Lloyds TSB and HBOS) through a ?500bn package overall that included partial nationalization of those banks by share purchases—a bailout package that outweighed all the proceeds of asset sales through privatization over the previous three decades. The rescue was followed by efforts to reduce those banks' balance sheets by sums in the order of ?1 trillion—an extraordinary and unprecedented financial operation.
This huge bailout of insolvent banks by asset purchases (paralleled, albeit in somewhat different forms, in the USA and several other European countries) turned a private-sector financial crisis into a public debt crisis. The bailouts abruptly increased UK national debt by about one-third, raising it to roughly double the level relative to GDP that had been seen for four decades.
That huge sudden debt spike in turn greatly increased debt servicing costs and thereby pushed up the budget deficit, which was further increased by the deep recession following the financial crisis, as tax revenues plunged and welfare costs and other recession-related spending soared. The resulting deficit, some 11 per cent of GDP at the peak, was much higher than that associated with the IMF bailout in the 1976 crisis discussed in Chapter Seven, more than double what had been seen for over half a century and higher than the deficit of any other G7 country. The recession was also marked by plunging stock prices, falling GDP (which at almost 5 per cent turned into the biggest drop in peacetime since the 1930s, though much less than in some of the worst-hit eurozone countries), rising unemployment (which jumped from around 5 per cent to 8 per cent within a couple of years, albeit to a much lower peak than in the 1980s and 1990s recessions), and a balance of payments deficit that increased sharply as international trade slumped, particularly in the eurozone.
When the financial crisis struck, Britain's long-running Labour Government, first elected in 1997, was more than half way through its third electoral term. It had to face a general election not later than 2010 and could not plausibly blame its predecessors for the financial crash, the recession, or the fallout for the public finances. Gordon Brown had succeeded Tony Blair as prime minister barely a year earlier, after having been Chancellor for ten years and presided over a doubling of public spending on electorally salient public services (notably healthcare and education) that the Conservatives in opposition had promised the voters they would match. In late 2008 Brown took a leading role in coordinating the actions of different countries in bailing out stricken banks and in a synchronized cut in interest rates to near zero by central banks (Brown incautiously claimed he had 'saved the world' by such actions). The Conservatives in opposition condemned the 'age of irresponsibility' that led to the financial crisis but supported the bank bailouts.
Shortly after the financial rescue, Brown helped to orchestrate a synchronized fiscal stimulus among G20 countries (part of a 'Keynesian moment' (Seccareccia 2012)). The UK government had increased spending and cut taxes in the face of ballooning debt and deficit some months before that, setting aside its 'golden rule' (of borrowing only to fund investment over an economic cycle, as discussed in Chapter Nine) and enacting a fiscal stimulus package claimed to amount to ?20bn, including a temporary cut in the standard rate of VAT from 17.5 to 15 per cent and bringing forward some ?3bn of capital spending projects.
But this so-called 'Keynesian moment' soon passed, both in the UK and the eurozone, as political support for fiscal stimulus to counter recession gave way to alarm about the scale of public debt and deficit and risks of default. And the policy consensus among the two major parties broke down at the end of 2008, when the Conservatives moved from a strategy of promising to match Labour's plans for increased public spending to opposing the Labour Government's stimulus package and proposing spending cuts to correct the public finances. For a time the Brown Government officially frowned on talk of 'cuts' evidently reflecting tensions between the Prime Minister and the Treasury (Darling 2011: 217), but political debate came to turn, not on whether a fiscal squeeze was needed to reduce debt and deficit, but on by how much, how soon, in what mix of tax rises and spending cuts—and on who was to blame for those levels of debt and deficit.
Politicians calling for a shift from fiscal stimulus to fiscal squeeze, in the UK and elsewhere, found their position conveniently supported by some respected economists. Those eminences included Carmen Reinhart and Kenneth Rogoff (2010), who in a paper much invoked at the time, though later discredited for errors (Herndon etal. 2014), claimed high debt levels were a 'drag on growth', and Alberto Alesina, who in comparative studies with colleagues showed that fiscal contraction in some cases had been followed by rapid output growth, particularly if contraction focused on spending cuts rather than tax increases. Alesina also claimed such policies in some cases could reap electoral dividends for incumbent politicians as well as fostering economic recovery (Alesina and Perotti 1997; Alesina and Ardagna 2010).
In the run-up to the 2010 general election, the Brown Government blamed the financial crisis on overseas forces beyond its control, while claiming credit for actions such as its 2008 stimulus package and tentative signs of economic recovery. It argued (much as did the 364 economists over the 1981 Conservative budget, discussed in Chapter Eight) that any fiscal squeeze should not start until recovery was well underway. But it put the standard rate of VAT back up to 17.5 per cent from the beginning of 2010, imposed a one-off 50 per cent tax on bankers' bonuses, announced a rise in compulsory National Insurance contributions to start the following year, and eventually went into the general election committed to a future revenue and spending squeeze.
Labour's deficit-reduction plan, presented by Chancellor Alasdair Darling in the Brown Government's final budget in March 2010, had a 'boiling frogs' character, in that it aimed to remove the 'structural deficit' over the course of two Parliaments (by 2016/17), and also involved delayed action in that it would not start until the year after the 2010 general election. The biggest reductions were scheduled in the final three years of the subsequent Parliament, at the end of which the structural deficit was expected to have fallen by more than two-thirds to 2.5 per cent of GDP. A Fiscal Responsibility Act based on these plans and applying to the following four years was enacted shortly before the election.
The planned fall in future spending relative to GDP and corresponding increase in revenue rested on assumptions of years of steady economic growth after the recession—dismissed by the Opposition parties as wildly optimistic. The plan involved roughly 70 per cent of the deficit correction to come from reductions in planned spending and about 30 per cent from revenue increases. It comprised some ?20bn reductions in overall planned spending (including a plan to cap public sector pay rises at not more than 1 per cent for two years) and approximately ?20bn in asset sales, ?16bn of which had already been announced. The figures implied reductions in planned spending of the order of 20 per cent in those policy domains not protected from cutbacks, but did not specify how those reductions would be achieved. The only exception was capital spending, where details of deep reductions were announced, amounting to cutting previous levels of spending by more than half over five years.
While Labour went into the 2010 general election with plans for a delayed- onset and slow-burn fiscal squeeze, the Conservatives proposed a swifter and earlier 'surgery without anaesthetics' approach. They claimed that, 'Gordon Brown's debt, waste and taxes have wrecked the economy and threaten to kill the recovery', and that far from risking deeper recession, early spending cuts were essential for growth and for limiting debt servicing costs by retaining the UK's top rating by the international credit rating agencies. They therefore promised voters to eliminate the structural deficit more quickly, and by more emphasis on spending cuts, dismissing Labour's plans for an increase in compulsory National Insurance contributions from 2011 as a 'jobs tax' that would increase unemployment. The third main UK party, the Liberal Democrats, offered several proposals for tax increases and spending cuts and their election manifesto stressed the need for deficit reduction. But they were unspecific about the timetable and extent of fiscal squeeze, broadly implying they would match Labour's plans if they won government (Chote and Emmerson 2014).
So while all major UK parties presented the voters with plans for fiscal squeeze in the 2010 general election, they differed over depth, balance, and timing. None offered specific plans for major cuts in programme spending, though much was made of the potential for large savings by greater operating efficiency. None mentioned higher VAT in their election manifestos, and indeed the Conservatives positively denied any plans to raise VAT.
In the run-up to the election, Labour ran well behind the Conservatives in the polls and did not expect to win an overall majority. At one point the Liberal Democrats moved ahead of Labour in the polls (and were not far short of the Conservatives) and the election result was widely predicted to be a hung parliament with minority government or a coalition. And as in 1997, the incumbent government laid some political traps for the Opposition parties. The most prominent one was a new top rate of income tax of 50 per cent for the approximately 300,000 UK taxpayers with taxable incomes over ?150,000, introduced in the 2009 budget but only coming into force immediately before the 2010 election. That tax increase produced little if any extra revenue and indeed broke a pledge made in Labour's 2005 manifesto not to raise top rates of income tax, but was justified as a way of sharing extra tax burdens fairly during a crisis, and presented a subsequent government with a likely political challenge if it tried to repeal the tax.
In contrast to 1992, the pollsters' predictions of a hung parliament proved correct, but the polls over-estimated the Liberal Democrats' share of votes and seats. The Conservatives won the largest number of seats, but fell some twenty short of an absolute majority. Labour lost over ninety seats—a loss slightly worse than in 1979 (and far worse in vote share). The Liberal Democrats with fifty-seven seats (slightly fewer than before) held the balance, but attempts by Labour to form a coalition with them failed, since the two parties together would still fall ten seats short of a parliamentary majority. Instead a Conservative-Liberal Democrat coalition government was formed, but the election result meant there was no clear electoral mandate either for Labour's slower and more tax-focused fiscal squeeze plan or for the Conservatives' alternative plan for an earlier, shorter, and more spending-focused squeeze.
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