Reflections on austerity and the Rogoff & Reinhardt stuff

There are of course a lot of “mays” and mights”, but on balance we can expect high government debt to be a constraint on the economy, although whether the likely implied constraint was ever enough to justify some of the tougher austerity measures that some governments have seemingly adopted on the basis of the RR study is unlikely.  In reality, we expect that there was a degree of political dogma involved that was being concealed behind the RR work.

Meanwhile, those that have sought to disprove or refute the RR work have often drawn attention to the UK’s seemingly quite reasonable (particularly by the standards of the time) rate of economic growth following the Napoleonic and other wars against the French in the Eighteenth and early Nineteenth centuries, which had left the British government massively indebted. But we may suspect that had other things remained equal, this high debt probably would have – and perhaps indeed did – reduce the economy’s rate of growth over the subsequent generation.

Of course we shall never know whether it did, and if it did by how much, because there were so many moving and changing conditions.  Apart from the likely ‘peace dividend’ of a drop in military expenditure, there was the re-opening of international trade links and the expansion of global trade into new regions.  There was also a lot of relatively exogenous innovation and invention, particularly Trevithick’s refinement of the steam engine in 1815 into a high pressure device that could power the industrial revolution. This was a key moment in boosting the supply side of the UK economy – just as it took the internet to unleash the full power of the computer, so it took the refinement of metal boring and Trevithick’s work to make steam engines properly useful.  Equally, the Repeal of the Corn Laws in the UK in 1846 supported a greater level and faster rate of urbanization which in turn boosted the prospects of manufacturing industries, at the expense of the rural economy, leading to what became known as the ‘great depression’.

These supply side reforms clearly lifted trend growth within the economy quite significantly and will therefore have obscured whether the high public debt burden mattered or not.  Similarly, and much closer to the present day, the arrival of the internet and the capital spending cycle that it initiated in the early to mid 1990s allowed the Clinton Administration to preside almost accidentally over a massive improvement in the US fiscal position with seemingly minimal effort.

But perhaps there are two key issues associated with the debate on RR’s work that are surfacing. First, it is apparent that there is a general and widespread tiring of austerity, with some key politicians calling for policy change. Against this back cloth, budget deficits in many Euroland economies are expanding again, the UK’s deficit has stopped contracting, the Japanese deficit is set to rise again, and if we do get a new global deflation scare later this year, it seems unlikely that the US will continue with its austerity drive.

Secondly, whilst high public debt burdens are likely a problem and this probably justifies moderate austerity over the medium term, solving indebtedness really requires a focus on growth, productivity and value added growth, and deregulation to support the supply side of the economy as with repeal of the Corn Laws. Having the economy grow out from under its debt burden, as the US showed is possible in the mid 1990s, is likely to have more political durability although there are still net winners and losers.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla