Friday, 19 October 2012

Welfare Spending Cuts – IMF data undermines the case

Welfare Spending Cuts – IMF data undermines the case
Christine Lagarde Director of IMF

This month the IMF has published its latest report into the world economy -  the  IMF World Economic Outlook . News stories talked of the report’s lowering of UK growth predictions, but much more importantly the IMF report contains a finding that undermines one of the central assumptions of UK’s economic policy. It provides substantial evidence that Government spending cuts do much more damage to the economy than had previously been thought
When the Government cuts its spending everyone agrees that the UK’s economic output (GDP) will be reduced – the question is by how much. The Government has underlying its policy and predictions the assumption that for every £10 of spending cuts only £5 will be lost to GDP. What the IMF report says is that for every £10 of spending cuts somewhere between £9 and £17 of economic output is be lost. In the jargon the fiscal multiplier is not 0.5 as previously thought but varies between 0.9 and 1.7.

The implications for economic policy are huge. Many counties, the UK included, are reducing their levels of borrowing by rapidly cutting government expenditure. Slow economic growth reduces government income and reduces the government’s ability to service its debts. So borrowing less can make a nation worse off if it hurts economic growth too much. If the effect of spending cuts is 2 to 3 times more than anticipated then policy needs revised - and quickly.

As can be expected a number of people have challenged the data, and it will take time to reach a new broadly accepted position on the effects of cuts. What is fascinating is the extraordinarily poor evidence base for the previous consensus and the numbers that underlie the Government’s current forecasting. Moreover the Government numbers for economic multipliers are based on the data of the past 30 years unaltered since the economic crisis. It is not surprising that the current climate has changed the effects of government spending dramatically. What is surprising is that many economists and politicians are unwilling to even contemplate the possibility that the facts are changing – even in the face of the new IMF data.

The driving force behind huge swathes of the austerity policies which are causing pain to the poorest all round the world  appears not to be strong evidence but worryingly inflexible ideology. As someone who in my previous career designed new vaccines it shocks me that the level of evidence necessary to test a new medicine on ten volunteers appears to be several orders of magnitude greater than the level of evidence required to impose a potentially catastrophic economic policy on billions.

Welfare spending makes economic sense.

Economic case for further £10Bn of Welfare Cuts undermined
The economic multiplier story has a further twist as everyone acknowledges that different types of government spending have different economic effects. If the money government spends goes to a person or company that in turn spends the cash quickly, then this will have a good economic effect (or high fiscal multiplier). If the money is put into savings or spent abroad, this is economically inefficient government spending (with a low fiscal multiplier).

Poor people have no choice but to spend their money quickly. Poor people have no choice but to spend their money in the UK. For this and a number of other reasons welfare is an economically efficient way to spend government money. Moody’s, a stalwart of the US financial establishment as well as the world’s largest credit ratings agency, in a US study estimated that for each $1 spend on welfare the economy $1.73 of economic growth was generated. The study was performed in 2008, pre-crisis, and all indications are that performed today, the benefit of increasing welfare spend would be considerably more. They also noted that the methods of stimulating the economy preferred by the UK Government – tax breaks to business and people higher up the income spectrum - were much less effective at generating growth, with $1 of government money adding only $0.34 to $0.50 to the economy, largely because the money is not spent by the recipients quickly.

The Effects of Further Welfare Cuts.

You can forget the maths and the jargon if you want but the implications of the data should be remembered. The Churches have argued that hurting the poorest most in public spending changes is morally wrong as well as being socially divisive. The IMF and others have now produced strong evidence that hurting the poorest is also economically damaging.
It is now difficult to find any evidence for the view that the £10Bn of further welfare cuts as announced last week would be either morally, socially or economically wise. Let us hope the evidence reaches the policymakers before further harm is done to the most vulnerable communities in this country.