Austerity: There is an alternative and the UK can afford to deliver it

“A decade after the financial crash, people need to know that the austerity it led to is over.” These were the words of the Prime Minister, Theresa May, at last year’s Conservative Party Conference. Speaking directly to voters at home, she argued that their “hard work had paid off” and that “the end is in sight”. This seemingly momentous shift in policy, she contended, was a result of its success: “because you made sacrifices, there are better days ahead”. But the truth is fairly obvious. Austerity has failed.

It is now clear that by taking demand out of the economy, right at the moment when firms and individuals were also tightening their belts as a result of the 2007/8 economic crash, cuts in government spending have stifled economic growth. Recent estimates from the New Economics Foundation (NEF) - using numbers produced by the Office for Budget Responsibility (OBR) – confirm this (Stirling, 2019). They find that the cumulative effect of austerity has been to shrink the economy by £100bn today compared to what it would have been without the cuts: that is worth around £3,600 per family in 2019/20 alone (ibid).

Given this, it is unsurprising that austerity has also failed to deliver in terms of its fiscal objectives, with the government pushing back and ditching successive targets to reduce the deficit. As lower growth led to lower business profits and wages this, in turn, resulted in less tax revenue (Krugman, 2015). It also increased non-discretionary spending, such as unemployment benefits and tax credits (ibid). Thus, making the reduction of the fiscal deficit – the difference between what government spent and what revenue it raised – more difficult, even as discretionary spending was being cut.

Likewise, a country’s debt is usually judged to be sustainable or not, in relation to its wealth (GDP). This makes intuitive sense. People judge the affordability of a mortgage not by its absolute size but in relation to their salary and the total value of the house. At an economy-wide level, this means that if we experience economic growth, debt becomes less problematic: it shrinks as a proportion of GDP. Whilst if the reverse happens – for example cuts in governments spending slows or reverses growth – debt actually becomes less sustainable. This is what happened in the UK and across Europe over the last decade (ibid).

And, then there is the staggering social cost of the cuts. Crime is up. Life expectancy has stopped rising but inequalities are growing again. Over a million people a year are now using foodbanks. Homelessness has more than doubled. And poverty has started to rise once again: one-in-three children and around one in five pensioners have now dropped below the poverty line (DWP, 2019). In the deluge of statistics, it is easy to lose sight of the fact that these are real people, families and communities, who rely on government support to get by, and who have been devastated by austerity.

Inevitably, this failure has also had significant political ramifications, with the general public appearing to have finally lost patience with austerity. The latest British Social Attitudes Survey finds that support for higher taxes and spending has risen to 48 per cent, higher than at any time since 2004 (BSAS, 2018). Eight in ten people want more spending on the NHS and seven in ten, on schools (ibid). This is one of the reasons often cited for both the Brexit vote in 2016 (Fetzer, 2018) and the Conservatives’ poor election performance in 2017.

Meanwhile, austerity is still affecting our public services today. The government may have given the NHS a cash boost last year, but most other public services face further significant cuts. For example, the Institute for Fiscal Studies (IFS) estimate that even if the government locks in a moderate overall spending increase over the next five years, because of commitments to protect certain areas of spending, the remaining ‘unprotected’ areas - including most aspects of social security, prisons, local government and adult education - are facing an average annual cut of 0.4 per cent per year (Emmerson et al, 2019).

This means that far from the UK “ending austerity” its economy remains in a form of fiscal purgatory, with cuts still working their way through the system. At the same time, the UK’s population continues to grow and age. This will require additional investment to simply maintain the existing level of services and benefits for citizens. This all points us towards a basic but as yet unanswered question: what does "ending austerity" really mean? Without a clear response to this, politicians can continue to get away with big talk but limited action.

What does 'ending austerity' really mean?

Any answer to this question must begin with a response to an even more challenging issue: what do people want government, and in particular the welfare state, to achieve? Of course, no one wants more spending just for the sake of it. As a society, we at IPPR argue that more spending is desirable in order to achieve the kind of society we aspire to create for the future.

Building on the work of IPPR’s ground-breaking Commission on Economic Justice (CEJ) final report (CEJ, 2018), published last year, we argue that we want a society that simultaneously delivers both prosperity and justice for everyone. Within this broader objective we believe that the welfare state should help deliver four main objectives. These are:

1. Ensuring thateveryone achieves a basic minimum standard of living, meaning enough income to live, and access to the basic goods and services - such as housing, an education and healthcare - needed for a good life.
2. Narrowing inequalities in wealth, income and power, including redistribution across different geographies and groups of people (e.g. genders, races and classes etc.).
3. Unlocking the potential of all people and the wider economy, by maximising everyone’s human capital and reducing barriers to people achieving their aims and ambitions.
4. Creating a stable and cohesive society, by building shared spaces, institutions, identities and interests that enable relationships, trust and solidarity to develop.

Delivering on these ambitions is not a simple task: it will not happen overnight. But it is far from impossible. Over the last century humans have radically reduced poverty across the globe; cured some of the deadliest diseases and doubled life expectancy; and invented digital technologies, including the internet, that were previously unimaginable. Bigger and better government - through the funding of research and development (Mazzacato, 2011), the creation of the welfare state (Deaton, 2001) and by the setting of rules and regulations that shape and manage markets - has played a key role in all these achievements.

As we look ahead to the challenges of the rest of the 21^st Century, at IPPR we believe we must once again fully marshal the power of government to deliver a more prosperous and just society. But to achieve this - and the four overarching goals of welfare policy set out above - we argue that the government must address four killer “social deficits”. These deficits speak to the failings of our existing welfare state as well as the priorities for reform going forward. It is these “social deficits” that have been keeping most ordinary people up at night, whilst politicians have been focussed purely on the fiscal deficit:

• The “care deficit”. Caring responsibilities in the UK, for both young and old, often fall onto family or friends. Huge cuts in social care funding and underinvestment in childcare create inequalities in who receives care and the quality of that care, which reduces dignity and limits potential. Unpaid care in the UK is valued at over £132bn annually (Buckner and Yeandle, 2015) and has grown rapidly since the crisis, with the overwhelming majority of this care provided by women.
• The “skills deficit”. A combination of technological change and globalisation is fundamentally re-shaping the labour market, with a growing number of low paid and low skilled jobs susceptible to automation, putting up to 44 per cent of jobs in the UK economy at risk (Lawrence et al, 2017). Avoiding rising unemployment and loss of skills will require a significant investment in education, training and ongoing development to help people gain employment and progress in the labour market (Dromey and McNeil, 2017).
• The “health deficit”. Since 2010, life expectancy has consistently risen over the last century, but this trend has now stalled in the UK (Marmot, 2019). Health inequalities are also significant, with the poorest in society living 8.4 years less than the richest. Meanwhile, on average, each of us will live nearly one-fifth of our life in ill-health, with this proportion rising year by year (PHE, 2017). We need more investment in prevention, public health, the social determinants of health and the NHS to address these challenges.
• The “security deficit”. Our social security system has become increasingly patchy with poverty for both children and pensioners rising again – now encompassing 30 per cent of children (up from 27 per cent in 2010) and 16 per cent of pensioners (up from 14 per cent in 2010) (DWP, 2019). Rough sleeping has risen by 250 per cent since 2010, with more than a million people now forced to rely on foodbanks. This is both morally wrong and economically costly.

Seen in this light, defining the “end of austerity” becomes a clearer task. It means more than simply stopping or reversing the cuts, it means increasing social investment to deliver a “social surplus” in the UK across these four domains. And it requires investing in public services and social security to repair the damage done by a decade of austerity, to ensure that as a country we are ready to embrace the challenges and opportunities of the decades ahead.

How much is enough?

Determining the ideal level of government spending to address these “social deficits” is a tricky task: it would need us to set out and fully costed manifesto of policies across each of these areas of policy. As part of IPPR’s new “Fairer Welfare” programme - which we will launch later this year - this is exactly what we intend to do. But in the meantime, we can get a sense of the scale of spending that might be necessary by looking at other developed economies.

Using three main criteria - GDP per capital between $30,000 and $60,000, reasonable population size (more than 5 million people) and similar cultural and political histories (European, excluding ex-Soviet Union dominated countries) - we can identify a group of countries broadly comparable to the UK. This comprises Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Spain and Sweden. We can then isolate their spending patterns, in terms of both quantity and allocation, and compare them to the UK. The results are illuminating (figure 1).

We find that on average these countries spend 48.9 per cent of GDP on public spending, compared to just 40.8 per cent in the UK. Furthermore, whilst the UK’s spending has fallen by 7 percentage points - from around 47 per cent of GDP to 40 per cent of GDP - since the onset of austerity, the comparable fall across these countries is just 3 percentage points. Moreover, if the UK were to match their current levels of spending tomorrow it would be worth £2,500 per person per year, of which £1,800 would go towards social spending; meaning health, education and social security.

Figure 1: UK and European spending (% of GDP)

Source: OECD

Of course, this additional spending doesn’t come out of thin air: there is no magic money tree. On average European countries have higher taxes with revenue totalling 41.8 per cent of GDP compared to the UK at 33.3 per cent. In Europe this additional revenue is sourced primarily from taxes on corporations and on workers, often as part of social insurance schemes. But in the UK, as IPPR has previously recommended, significant additional revenue could be raised through increasing the rate of corporation tax in line with the European average, reforming income tax but in a way that protects those on low and middle incomes, and changes to the way in which we tax wealth (CEJ, 2019).

Figure 2: UK and European tax revenue (% of GDP)

Source: OECD

Tax reform is never easy. In the UK, we're now experiencing the longest pay squeeze for people on low or middle incomes since Napoleon marched across Europe (Tily, 2018). Morally, economically and politically it is therefore very hard to ask ordinary people to contribute more, even if in theory they are supportive of higher taxes. And whilst taxing those with a greater ‘ability to pay’ - businesses and the wealthy - may sound easy, it is politically very tricky. Moreover, although there is undoubtedly more potential to tax the rich, there are also limits to this revenue stream.

As a result, politicians have historically tended to shy away from explicit tax rises and have relied instead on economic growth and “fiscal drag” to fund spending increases. But this strategy - especially in an era of low or no growth – is no longer sustainable. At some point, if we really want to tackle the UK’s “social deficits”, government is going to have to consider higher taxes and grasp the nettle on tax reform.

However, the potential payoff for doing this is evident from a glance at the performance our European neighbours, across a whole range of social outcomes. The UK currently sits in the bottom half of rankings on poverty, inequality and health and wellbeing outcomes – and is an average performer in terms of educational outcomes (see figure 3). It is only on unemployment that we outperform this group of countries. Put more simply: people in other countries may pay more tax but it looks as though they are better off as a result.

Figure 3: IPPR social outcomes index, UK rankings

Source: OECD

What’s more, the inevitable criticism from the right – that higher social spending will inevitably inflate debt and lead to lower economic growth – doesn’t seem to bear scrutiny either. On average debt levels in the UK have only been slightly lower, at 72 per cent, compared to 80 per cent in comparator countries over the last two decades. At the same time, growth rates over the same period have been almost identical: 1.9 per cent in the UK compared to 1.6 per cent across the comparator countries.

These findings are increasingly backed up by a number of more comprehensive studies which show no consistent link between the size of government and growth (Bergh and Henrekson, 2011). This makes intuitive sense: if social investment is effective and productive (for example if it increases human capital) then it will induce growth, but if it is ineffective (or reduces the supply of labour) it will have the opposite effect. This implies that if we spend wisely, additional social investment could in fact help stimulate economic growth in the UK.

Conclusions

For too long we have been told that there is no alternative (“TINA”) to cutting the welfare state. Many politicians - on both sides of the political divide - have argued that with an ageing society and a budget deficit, the only responsible thing to do is to tighten our belts and live within our means. But a brief glance at the experience of other European countries suggests that this argument is specious. Amongst our peers, higher levels of social investment is not the exception but the norm; not seen as radical, but mainstream.

We must no-longer let people tell us that ‘ending austerity’ is unaffordable: with “social deficits” in care, health, skills and security, we can hardly afford not to invest. More and better social spending can deliver better social outcomes, whilst maintaining or promoting both economic growth and fiscal sustainability. In the coming months, IPPR will set out exactly how to achieve this, establishing both where this money can come from, and how it should be spent. In the meantime, the message from this analysis is clear: whilst we may be leaving the EU, to “end austerity” we must become more, not less European.

References:

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