GROWTH COMMISSION RESPONSE: 5. THE TRUTH ABOUT AUSTERITY

23 July 2018

Claims that the economic model proposed by the Growth Commission is ‘anti-austerity’ do not stand up to scrutiny.

There appears to have been a concerted effort on behalf of the report’s sponsor and authors to claim that it proposes an economic model that would have avoided the austerity of the last 10 years.

The clearest example of this was a statement made by the report’s Chair in an interview with the National newspaper:

“If the model we have suggested for reducing the deficit was applied to the last 10 years we would have eliminated the Tory austerity cuts to the Scottish budget.” – Andrew Wilson^{1Growth Report author: Unionists think independence case is now stronger, The National, 2nd June 2018}

This echoed similar statements made by First Minister Nicola Sturgeon during FMQs and Growth Commission member Kate Forbes^{2Appointed Public Finances and Digital Economy Minister in the June 2018 reshuffle} MSP on BBC’s Question Time:

“If the spending recommendations of the Growth Commission had been applied over the past ten years […] it would have eradicated austerity in Scotland. That is the reality” – Nicola Sturgeon^{3FMQs, May 31st 2018}

“Over the last 10 years the Scottish Budget has been cut by 8.5%; in contrast, this report predicts that if we had been an independent country our spending could have increased by 5% over those 10 years” – Kate Forbes^{4BBC Question Time, May 31st 2018}

There are no such claims made in the 354 page report, although the report does assert that “Scotland should explicitly reject the austerity model pursued by the UK in recent years.”^53.162

To test these claims and whether or not the report’s assertion is consistent with the report’s actual recommendations, we first have to decide what is meant by ‘the model we have suggested for reducing the deficit’.

Reading all 224 clauses of the summary, there are only five specific recommendations related to ongoing deficit reduction. Two are unequivocal:

3.184: Target a deficit value of below 3 per cent within 5 to 10 years.
3.185: National debt should not increase beyond 50% of GDP and should stabilise at that level.

Three are more subjective, confusingly caveated and not necessarily consistent with the first two:

3.186: Borrow only for public investment in net terms over the course of the cycle.
3.187: During the transition period real increases in public spending should be limited to sufficiently less than GDP growth over the business cycle to reduce the deficit to below 3% within 5 to 10 years. At trend growth and target inflation rates this would mean average annual cash spending increases of above inflation in contrast to the Scottish budget experience under the UK regime of recent years and that scheduled for the remainder of the current planning period.
3.188: The impact of fiscal management on growth must be tended to and it should be noted that this rule will apply over the business cycle. This means that in periods where growth is expected to be substantially lower than longer-term trend, it will be possible to increase public spending to create the necessary economic stimulus to increase growth.

Ambiguity is introduced into these summary recommendations by reference to ‘the business cycle’, a term which is open to interpretation and not defined within the report.

Whatever is meant by ‘the business cycle’, it’s clear it must complete within a 10 year time-period or it wouldn’t be possible to comply with the recommendation for increases in public spending to be “limited to sufficiently less than GDP growth over the business cycle to reduce the deficit to below 3% within 5 to 10 years.”^63.187

The report itself observes that none of the 12 benchmark SAEs run a deficit as high as 3% and in fact most run a surplus.^7B7.12 Given that 3% is also defined as the ‘excessive deficit threshold’ by the EU^{8Launching an Excessive Deficit Procedure}, it seems clear that the Commission concludes that running a deficit of less than 3% is a requirement for fiscal credibility and recognises the need to achieve this within 10 years (although as we’ll come on to argue in chapter 6, this does not appear to be a sufficiently aggressive target).

The detail within Part B drives this point home:

“... it is important to have a clear, credible fiscal trajectory planned. This should move with pace, aiming to achieve a sustainable fiscal position within 10 years. This timeline is necessary to ensure consistency with EU fiscal rules, as well as recognising the limits with financing fiscal deficits of anywhere close to the current level.”^{9B8.71, B8.72}

If any doubt remains, the “Fiscal Rules” laid out in part B remove it:

“From this work, we conclude that the immediate fiscal policy priorities for Scotland will be to agree a binding framework to ensure:

The deficit is reduced to below 3 per cent of GDP within 5 to 10 years
That national debt does not increase beyond 50% of GDP and stabilises. This will automatically constrain what fiscal deficits are allowed
Borrow for public investment only over the course of the cycle”^10B12.2

Our interpretation of the report’s recommendations is therefore that getting an independent Scotland’s deficit below 3% within 10 years^{11The Commission insists on using the phrase “within 5 to 10 years” - this is clearly intended to mean “within 10 years”} would be a non-negotiable priority and constitute their first Fiscal Rule. If this is not a non-negotiable priority, then we fail to see how the Commission can credibly claim to be seeking to emulate its chosen 12 successful SAEs (or indeed even begin to build the reserves required for its currency strategy or to prepare to meet the EU’s entrance criteria).

In the quote at the beginning of this section, the report’s Chair Andrew Wilson referred to “the model we have suggested for reducing the deficit” and it seems clear to us that he is referring to the strategy outlined above and specified thus:

“Deficit Reduction Policy: this should be established with a target of delivering the initial deficit target of under 3 per cent of GDP within 5 to 10 years. Public spending increases in transition should be limited to sufficiently less than money GDP growth to deliver this.”^{12Part B, recommendation no. 42}

The Policy goes on to state that “At trend rates of growth and inflation this would allow annual average cash increases of above inflation.” But, as we will demonstrate, only on the basis of assuming GDP growth rates greater than 1.0% pa in real terms during the initial consolidation period could the Commission justify their statement that “For the initial consolidation period, we recommend modest real terms increases in public sector expenditure.”^13B12.16

To be absolutely clear: unless they are prepared to break their own first (and frequently stated^{14The first Fiscal Rule as specified here is mentioned more than 10 times within the report}) Fiscal Rule, real terms spending increases would only be possible if real GDP growth rates were sufficiently high to allow this – in their worked example that figure would be need to be above 1.0%.^{15If starting with the deficit position projected for 2020-21 – were the deficit higher, the 1.0% would need to be commensurately higher as well}

Having understood what ‘the model’ is, it is a relatively trivial exercise to show what the implications of applying this model would be under different conditions. Indeed the Growth Commission offers such a model to produce their Fig 12-2 (our Figure 3), where they show the rate at which spending growth would have to lag GDP growth to achieve their ‘below 3% within 10 years’ first Fiscal Rule:

“B12.18: At Scotland’s long-term trend GDP growth rate of 1.5%, and inflation at 2%, this would mean that nominal increases in public spending of 2.5% would reduce the inherited deficit from 5.9% of GDP to less than 3.0% of GDP by year 9 (Figure 12-2). Over a ten-year period that would require borrowing that would build up to 36% of GDP, well within the 50% limit of the proposed fiscal framework.”

This illustration makes clear that, using the Commission’s optimistically projected “legacy deficit”, spending growth would need to be 1% behind GDP growth to satisfy their first Fiscal Rule.

Figure 3

/image/deficit.png

We have been able to recreate the Growth Commission’s model to a reasonable degree of accuracy^{16Our key sanity check is not just the deficit outcome but the implied debt/GDP after 10 years. In our simple model this comes out as 36%, identical to the figure the Commission quote [B12.18]. It should be noted that this simple model implicitly and somewhat simplistically assumes that revenue/GDP is not affected by spend/GDP} and this allows us to place the assumed decrease in spend as a percentage of GDP (spend/GDP^{17It looks as if the Growth Commission are using GDP including N sea oil in the denominator – that is what we have assumed (it is not a major factor when it comes to the conclusions drawn)}) in historical context^{17Note that the GDP figure used for the denominator in this graph is GDP including North Sea Oil.}[Figure 4].

Figure 4

/image/ofAllGDP.png

The graph clearly shows that the implied reduction in spend/GDP is far greater than anything Scotland has recently experienced (or is forecast to experience within the UK).

The report is correct when it states that “The analysis set out in this report shows that the target of a deficit value of below 3 per cent within 5 to 10 years can be achieved without any assumptions in increased growth.”^{183.192 – “within 5 to 10 years” is a strange choice of words given that “within 10 years” is clearly what is meant} However, applying the report’s first Fiscal Rule (to get the deficit below 3% within 10 years) and deficit reduction model (for spend growth to be sufficiently lower than GDP growth to achieve this) can only lead to real spending growth if real GDP growth is greater than 1%.^{19Assuming a starting deficit of 5.9% and revenue/GDP being unaffected by spend/GDP}

In fact, if we remove the cost saving optimism from the Growth Commission’s assumptions (which is what causes such a large step down in spend/GDP in the graph above) then spend growth would have to lag GDP growth by 1.5% to still get the deficit under 3% within 10 years.

Claims, like those made by the First Minister, that the Growth Commission recommendations would have “eradicated austerity” over the last 10 years simply do not stand up to scrutiny. Average real onshore GDP growth in Scotland over the last decade has been just 0.8%^{20Using 2016-17 GERS figures and applying the HMT GDP deflator} and 10 years ago the onshore deficit was over 8.7%.^{218.7% based on total GDP, 10.4% based on onshore GDP} This means that strictly applying the Growth Commission model – which requires spending growth to be “limited to sufficiently less than GDP growth”^223.187 to get the deficit below 3% within 10 years would actually have required spending growth to be c.1.5% behind GDP growth.

A simple graph (Figure 5) shows the difference between what actually happened to spend/GDP under ‘Westminster austerity’ and what would have happened if spending growth had been constrained to either 1.0 % or 1.5% less than GDP growth over that period.^{23The denominator used here is total GDP (including North Sea) whereas the GDP growth used to define spend growth is onshore only – this is why spend/GDP actually goes up in the 1% scenario, because offshore GDP declined over this period.}

Figure 5

/image/spend_GDP_Scenario.png

The impact of applying the Growth Commission’s recommendations retrospectively is unsurprising – they lead to materially less spending in Scotland than actually occurred over the last decade.

If spending growth had lagged GDP growth by 1.0% over the last decade: total cumulative expenditure in Scotland would have been £53bn less than actually occurred and in 2016-17 spending would have been running at a rate of £5.6bn pa (7.8%) less. The onshore deficit would have been reduced to 4.8% (i.e. the first Fiscal Rule would still not have been met)
If spending growth had lagged GDP growth by 1.5% over the last decade: total cumulative expenditure in Scotland would have been £58bn – £66bn^{24The lower end of the range is arrived at by smoothing the spending figures to reflect the Growth Commission’s ‘over the business cycle’ caveat (i.e. spending is not reduced as aggressively when short-term dips occur in GDP growth)} less than actually occurred and in 2016-17 spending would have been running at a rate of £8.4bn pa (11.8%) less. The onshore deficit would have been reduced to 3.0% (i.e. the first Fiscal Rule would have just been met^{25Which confirms the 1.5% figure is correct})

This finding is intuitively obvious given Scotland’s onshore deficit was actually 8.4% in 2016-17. The Growth Commission’s first Fiscal Rule would have required that to be brought down below 3% over the preceding 10 years by limiting increases in spending. The net result would therefore have inevitably been a dramatic reduction in spending, far beyond anything seen under what the Growth Commission refer to as the “austerity model pursued by the UK”.

The Commission tacitly accepts the need for disciplined control of spending to reduce the deficit. As well as an oblique reference to Ireland’s “necessary actions to deal with the financial crisis”^26A3.56, the report states:

“Successful improvements in public finances have generally been structured with an emphasis on spending control [...] the empirical work consistently finds that deficit reductions that are successful [...] tend to focus on spending control policies that are clear” – [B7.26]

“Countries with stronger budgetary processes were more successful in reducing debt. It is notable that countries that implemented stronger budget processes also had a better fiscal experience through the crisis” – [B8.6]

Indeed by not proposing to reverse any of the recent or planned spending cuts^{27In fact the Commission explicitly states “Scotland’s replication of UK budget spend currently allocated to Scotland in a number of areas is assumed to be unchanged for our analysis including welfare, pensions, economic development and scientific and university research funding.” [3.140]}, the Commission implicitly accepts that these are a necessary (but not sufficient) condition for making the Scottish economy fiscally sustainable on a stand-alone basis. The report states “planning for additional cuts over and above those already planned is likely to be counter-productive”^28B4.20, but makes no proposals to reverse any of the previous cuts. This means that the Commission makes no plans for spending increases to reverse such policies as the benefits cap, the 2-child tax credit cap or increases to the state pension age.

We note that the alternative of not reducing real terms spending but instead hoping that increased spending will act as a fiscal stimulus to drive growth (sufficiently to still reduce Spend/GDP) is hardly mentioned in the report. It does appear as a rather equivocal and non-committal final recommendation in Part B (recommendation No. 43):

“Transitionary Fiscal Stimulus a fiscal stimulus to growth should be considered and consulted on depending on the prevailing economic circumstances and the perspectives and price required by debt providers.”

To summarise:

The anti-austerity rhetoric is completely disconnected from the detail of the commentary and recommendations.
If applied retrospectively, the recommendations would have led to far greater austerity than Scotland has experienced over the last decade and led to roughly £60bn less spending.
The commission has claimed to reject the existing ‘austerity model’ but has replaced it with one that is necessarily harsher. Necessarily so because, unlike the situation for Scotland remaining within the UK, the Commission suggests than an independent Scotland would have to get its deficit below 3% within a decade.
Based on realistic assumptions, the Commission’s recommendations would almost certainly lead to many years of even greater austerity for an independent Scotland.

We are not alone in drawing these conclusions – commentators and analysts from across the political spectrum share our view:

“It’s a continuation of austerity. If public spending growth is one per cent less than GDP growth, that’s austerity.” – David Phillips, IFS associate director^{29IFS: Independent Scotland ‘would face continued austerity’ under Growth Commission proposals, Holyrood Magazine, 6th June 2018}
“In fact, a unionist blogger did the maths on what Growth Commission rules would have done over the Tory austerity years and it would actually have been worse. We quickly ran the numbers to check – and I'm afraid to say he is right” – Robin McAlpine, Common Weal^{30Robin McAlpine: From Yes Bikers to Yes Bankers - Why the Growth Commission gets its strategy terribly wrong, CommonSpace, 7th June 2018}
“what the Commission is saying by adopting these objectives, which will cruise all others in the report, that Scotland should welcome austerity in its place” – Richard Murphy, Tax Research UK^{31The Scottish Growth Commission gets its economics very badly wrong, Tax Research UK, 25th May 2018}
“[The Growth Commission] does not reject austerity in reality. It would create the conditions for austerity politics to thrive” – Jonathon Shafi, Co-founder of the Radical Independence Campaign^{32https://twitter.com/Jonathon_Shafi/status/1003632589465415680}