What has happened to Britain’s ‘Treasury view’?

While David Cameron’s Conservative government used austerity to their political advantage, Boris Johnson’s government has so far given it a wide berth

This is the third blog in a new series of blogs by undergraduate students on the ‘Britain in the Global Economy’ 3rd year module, which is convened by Dr Scott Lavery at the Department of Politics and International Relations at the University of Sheffield. Read the first and second blogs in the series.

When the Conservative party entered government in 2010, their headline economic policy was to eliminate the budget deficit through reducing public expenditure. The hope was that the pursuit of ‘austerity’ would stimulate economic activity and result in a surge of investment. This went against mainstream economic thinking. Predictably, it did not deliver. The UK witnessed the slowest economic recovery in modern history. By the end of the Coalition government, the deficit remained stubbornly in place while underlying economic challenges – low productivity, regional imbalance and the proliferation of insecure work – were exacerbated. 

The Coalition’s pursuit of ‘austerity’ was not new. It closely aligned with a long-standing mode of thinking within British government often referred to as ‘the Treasury view’. This is the idea that the budget deficit – the difference between government expenditure and revenue – needs to be reduced regardless of the economic circumstances. The Treasury view sees balancing the budget and maintaining ‘sound money’ as key to supporting consumer and investor confidence.

George Osborne, the Chancellor at the time, hoped that austerity and the adoption of the Treasury view would result in what some economists referred to as ‘expansionary fiscal contractions’ and increased investment and consumption due to the crowding out effect. An expansionary fiscal contraction is an economic idea presented by the Italian economist Alberto Alesina. Alesina argued, against many in the economics profession, that enacting austerity during an economic slump would boost investment and employment, thereby stimulating economic growth. Key to this idea is the ‘expectations channel’, which is the idea that households and companies will anticipate future tax cuts following rapid deficit reduction, which in turn will produce increases in investment and employment.

However, when using the argument of expansionary fiscal contractions to defend his decision to implement austerity, Osborne ignored the fact that Alesina’s arguments had been contested by many within the economics profession. The IMF, for example, found that austerity needed to be implemented during an economic boom to be expansionary, not following an economic slump as it was when the Cameron government began its austerity agenda.

Osborne also used the ‘crowding out’ argument to justify the UK government’s economic programme. This argument suggests that public sector spending takes resources away from the private sector. Proponents of the crowding out argument suggest that by entering austerity and reducing public expenditure, private expenditure will increase. However, such reasoning ignores the self-defeating nature of austerity. Rapidly reducing government expenditure at a time when households and firms are also cutting back compounds fears of an economic downturn, as demand is sucked out of the economy. Therefore, instead of leading to greater private sector expenditure, austerity has the paradoxical effect of pushing down private expenditure as well. Consequently, it is unsurprising that following the introduction of austerity in 2010, there was a major fall in business confidence, with one report finding that business confidence was the lowest in two decades during the Coalition period.

In pushing the Treasury view and the crowding out argument, the Conservatives also ignored the economic realities of the British economy, as proponents of the Treasury view considered interest rates to be the main mechanism to stimulate investment during austerity. However, before the 2008 financial crisis interest rates were already low in the UK. Therefore, relying on reductions to an already low interest rate was a high-stakes gamble. Furthermore, by relying on already low interest rates to provide the desired ‘crowding in’ effect, the Conservatives ignored economic research which shows that demand has a greater effect on investment than interest rates. Consequently, the reduction in demand caused by the crisis in confidence created by austerity, destroyed the possibility of any significant investments into the economy.

Despite Osborne’s apparent disregard of mainstream economic opinion when adopting the Treasury view, its adoption was still a politically shrewd move. It allowed the Conservative party to create the impression that it was Labour’s overspending that led to the 2008 financial crisis. This allowed the Conservatives to simultaneously pitch themselves as the fiscally credible alternative that could be trusted to manage the UK’s economic recovery. Consequently, Osborne’s adoption of the Treasury view provided the Conservative party a route back into government, while presenting the ideal cover for spending cutbacks. This meant that the UK’s subsequent economic pain was a sacrifice for the Conservative party’s political gain.

What lessons might the Conservative’s embrace of the Treasury view in the post-2008 era have today?  Interestingly, the current Conservative government, has so far not embraced fiscal austerity in the same ways its predecessors have. Again, the reason is political. Public support for spending cuts is 50% lower today than it was in 2008. It is therefore perhaps unsurprising that the Johnson government – reliant as it is on a new coalition of voters in the so-called ‘red wall’ – has been reluctant to embrace spending cutbacks. Instead, Johnson’s government has taken a more Keynesian approach, adopting policies such as the flagship job retention scheme. Having been in government for over a decade the option of blaming Labour for spending cuts is no longer available. However given the dire state of the UK’s finances, Rishi Sunak, the present Chancellor, is warming to the idea of greater fiscal constraints and is becoming increasingly concerned as to how the Prime Minister’s bold promises to ‘level up’ will be funded. Whilst adoption of the Treasury view has thus far shown itself to be too politically risky; as the UK emerges from the Covid-19 pandemic it appears that Johnson’s populist instincts will clash with Sunak’s drive for fiscal prudence.

Whilst the challenges that Boris Johnson’s government face are very different to those faced by the Coalition government in 2010, it still confronts a difficult financial situation. But in contrast to the situation in 2010, adopting spending cutbacks would be a higher stakes political gamble for the Johnson government. The Prime Minister’s unwillingness to adopt the Treasury view due to low electoral support for spending cutbacks, despite objections from his Chancellor, demonstrates that the Treasury view should not be considered a fixed ideology within British government. It is instead an economic framework which is deployed only when beneficial politically.