Even after Brexit, austerity will remain a choice – not a necessity

14th February, 2018 6:00 pm

Part of Labour’s appeal at the general election was its ability to offer a credible alternative to austerity. A costed programme with realistic taxation and spending priorities showed that a different future was possible. Austerity was a choice – not an inevitability.

Since then British politics has been dominated by the complexities of leaving the EU. All economic debate must consider the expected impact of Brexit – it is impossible to discuss growth, employment, productivity, investment, markets or interest rates without mentioning it. Austerity is no longer centre stage.

It has been claimed that an economic shock from Brexit would have such an effect on output and government revenue that it would make Labour’s anti-austerity programme impossible. In a recent Guardian article MPs Heidi Alexander and Alison McGovern, leaders of the Labour Campaign for the Single Market argued:

“The reality is that a hard Brexit would so severely hurt the public finances that we would likely see a continuation of austerity and further strain on the NHS and other public services. If as a party we want to be able to fund the anti-austerity manifesto we put to the public in 2017, we can’t afford a multibillion-pound hit to the public finances.”

The claim about the size of the hit to public finances seems to be based on a misreading of the research into the long term economic impact of Brexit. The Treasury study released during the referendum, for example, calculated a post-Brexit reduction in tax receipts of £36bn compared with staying in the EU, but only after 15 years during which time normal economic growth would make tax receipts 45% higher than today – around £270bn more.

Nevertheless, Brexit will lead to a negative shock for the economy. The timing and scale of such a shock are unknowable but we cannot rule out a short term hit to national income and tax receipts. In that case, are they right to believe that a Labour government would be forced to return to austerity?

The difficulty with this proposition is that it repeats the logic of George Osborne’s original justification for austerity. From 2010, the then-chancellor argued that his cuts to welfare, cuts to public spending and freeze on public sector wages were “unavoidable”. The shock of the global financial crisis had pushed up government expenditure and reduced its income, producing a large deficit. Government could not go on spending more than it took in, he argued, and therefore a target was set to bring the budget into balance by 2015.

Osborne justified his actions by claiming that austerity would restore the confidence of financial markets leading to stronger growth. Economists – not just Labour supporters – pointed out that austerity would delay the recovery and that far from inducing growth, cutting government spending would reduce demand at a time when other sources of demand were weak. Households already suffering after the financial crisis would be further hit by the wage freeze followed by a cap. Firms would not invest without the prospect of stronger aggregate demand. There was no relief from trade as all wealthy countries faced the same constraints.

Experience over the next five years proved Osborne wrong and the anti-austerity case right. The recovery has been painfully slow and the weakness of GDP growth meant government income remained below expenditure. His policy was ultimately self-defeating.

The lesson is simple: faced with an economic shock, cutting government spending is disastrous. It is shocking to find Labour politicians resuscitating the Cameron era narrative in order to score points in the debate over single market membership.

If Labour were to be in power when the Brexit shock hits the economy, would it need to resort to austerity? If lower GDP led to a fall in government revenue, should spending on health and education be reduced and wage limits in the public sector reinstated?

Recent experience shows that it is best to sustain demand through government spending until the economy recovers. Labour should prepare for the Brexit shock with its policies on investment and industrial strategy. Even after Brexit, austerity will remain a choice and not a necessity.

Jos Gallacher is a member of the National Policy Forum’s economy commission.

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