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Why austerity doesn’t work

Austerity as practised is a recipe for disaster. But there is a better way

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Austerity is a disaster economically, politically and socially.

There are at least three reasons why.

The first is the Keynesian one. Paradoxically, austerity (reducing the size of the state, cutting public services, freezing wages) is a luxury. It can only be done acceptably in export-led economies like Germany and Canada where businesses depend mainly on foreign demand. The UK, on the other hand, is a low-wage economy that relies on domestic demand from consumers many of whom are earning less than before the crash of 2008, who have no savings and mountains of debt. The less they have to spend, the harder it is for UK businesses to prosper. Duh. The government’s tax take shrinks too, so that the date for paying down the public deficit continues to recede. As economist Jonathan Portes tweeted, ‘Failing to borrow long-term at negative real rates to fix roofs (& other things) over last 7 years an act of deliberate economic self-harm’. This is austerity as suicide.

The second reason why austerity doesn’t work is that the institutional framework, or social contract, that supported its logic isn’t there any more. Post-war western economies were built on the understanding that production and consumption were interdependent – one person’s wages bought someone else’s output – as embodied in the famous diagram of the circular flow of income at the beginning of Paul Samuelson’s Economics.

That began to break down in the 1970s and 1980s, when a persistent trope was that the private sector was being ‘crowded out’ by the public sector, which needed to be pruned back to allow entrepreneurial animal spirits to flourish to rev up the sluggish economy. Hence the rounds of privatisation, agencification and outsourcing that still continue.

But wind forward to today. It is quite clear that the capital markets that call the tune over corporate resource-allocation decisions aren’t remotely interested in the circular flow. They don’t care a fig about job creation – in fact the only innovation and investment they applaud is automation that cuts jobs. So whereas in the past companies automatically created employment as they grew, they no longer do. Companies now only create well-paying full-time jobs as a last resort, leading to the celebrated (possibly apocryphal) stand-off between Henry Ford II and union boss
Walter Reuther as they toured an advanced new manufacturing facility:

Ford: Walter, how are you going to get those robots to pay your union dues?

Reuther: Henry, how are you going to get them to buy your cars?

The internet aids and abets this fragmentation. In a classic bait and switch, using network effects and the massive cross-subsidies afforded by our meek acceptance of the devil’s bargain of ‘free’, the internet privileges us as consumers, but only by turning our jobs into gigs and micro-tasks, with equivalent effects on our wages.

This is austerity as reductio ad absurdum.

The final reason why austerity doesn’t work is the most fundamental and paradoxical of all. It is unknown to economics, and unfortunately to most managers too. It is that, as we have learned from systems thinkers and practitioners, managing by cost doesn’t cut costs – it increases them. This sounds counterintuitive. The conventional assumption, inherited from strategy and mass production, is that there is a trade-off between quality and cost. The better the service, the higher the cost; so the only way to cut the cost is to reduce the quality (or quantity, by rationing or otherwise restricting access).‘Services for the poor are always poor services’, Richard Titmuss observed as long ago as the 1960s.

But this is not inevitable. Here is a rare case where the cake can be had and eaten too. At a recent event, the chairman of pioneering peer-to-peer lender Zopa noted that ‘businesses that win customer service awards [like Zopa] are those that people don’t have to speak to. They don’t have to speak to you because the service works as it should do, from the tin.’ Contact centres are expensive, but firms like Zopa don’t have them – why would they? What’s more, being efficient at what it does – basically credit – doesn’t only benefit Zopa’s borrowers and savers. ‘It’s more fundamental than that, because if you’re good at credit and you get a reputation for it your cost of capital goes down… By being better at credit than any UK bank our cost of funds has gone down dramatically – way lower than any of our competitors.’ In a sector with thin margins, that’s an existential advantage. Building on what it has learned, Zopa is about to launch ‘the best consumer bank in the UK’. Can’t wait.

Like profits, costs are properly thought of as a consequence of the way you do something for a customer – an effect, not a cause. Done well, as at Zopa, the consequence is that costs fall. Done poorly, as at other banks, as at Grenfell Tower, as in countless other services, and costs rise. As another speaker at the same event lamented, ‘Why is it that we never have the time or money to do something right, but we always do to do it twice’?
Just as in a coupled system efficiencies amplify each other, so do inefficiencies. Consider prisons. The easiest way to deal with criminals is to lock them up. So that’s what we do. But prison is expensive. So governments repeatedly try to cut its cost by reducing staff numbers, economising on rehabilitation, and keeping prisoners banged up 23 hours a day.

But this is austerity as sheer management ineptitude.

The outcome: overcrowded jails as dangerous powder kegs that instead of returning offenders to society as functioning citizens, send them back as professional villains and drug addicts. A shredded probation service offers little support for those discharged, with the predictable result that most of them are expensively back inside within months – and the pressure grows for yet more prisons. In other words, prison makes the presenting problem worse. Research in Manchester shows that 80 per cent of crime is committed by a relatively small number of individuals and families who are known to the police – and to many other public agencies. Straightening them out would reduce demand not just on the criminal justice service but across the entire public sector.

As is being proved in right-wing US states such as Texas and and Utah. Appalled by the soaring cost of dealing with reoffenders and homeless (often the same individals), they find it far cheaper to house each client and give them a tough minder until their life is stabilised than to leave them to clog up police cells and homeless shelters or return to prison. Believe it or not, Texas is closing prisons; in 2014 Utah claimed it had reduced homelessness by three-quarters and was on the way to eliminating it altogether.

You wouldn’t call this ‘austere management’ – it submits no one to hardship and it should not be something exceptional. To the contrary: it gives people what they need, neither more nor less, with no spare effort or waste. Unlike the economic version, it has equal appeal to right or left. Let’s call it instead ‘frugal’ – as all management should be, whether in the best or worst of times.

4 Replies

4 thoughts on “Why austerity doesn’t work

  1. Whiteley

    Strong article, as usual. I strongly agree with you about the absurd false economies when public sector spending is cut unintelligently. I could add others: as Haig Nalbantian and other economists have pointed out, you can reduce operating costs while increasing pay, if done smartly. There isn’t even a linear relationship between wage cost and operating cost. So governments ought to be obliged to make an economic case for a pay freeze, as well for as a pay cut. But I do question the phrase ‘austerity doesn’t work’. To a very large extent, this is a tautology. The UK economy will have austerity for as long as there are twin deficits, and neither of the main parties confronts economic underperformance directly, as Schroeder and Merkel have done in Germany, with accords to exchange wage rises for productivity growth. The main cause of austerity is the taxpayer taking on the colossal costs of the banking bailouts, a result of fraud and irresponsible speculation, made possible by regulatory capture. So to have pre

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  2. John Carlisle

    What happened to the rest of Whiteley’s comment?

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  3. Whiteley

    …sorry, continued: So to have prevented austerity, we’d have to go back much further than seven years. You’re right that a smaller state doesn’t guarantee enterprise and employment growth; but sadly a bigger state doesn’t guarantee social justice or reduced austerity. It may do, eg Sweden, or it can be a complete disaster, like Venezuela. Tories call for a smaller state, Labour for a bigger state. What we actually need is a better state. And better governance, accountability and less corruption. I would like to be looking forward to a Labour Government, but I’m nervous, especially combined with a messy Brexit. If you were Shadow Chancellor, Simon, I’d have more confidence ….

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  4. DCarroll

    This carries Simon’s strengths: focus, shape and necessary argument-leadership so clear the State will have difficulty refuting it. If they even hear it! When I’m your agent, I’ll get you regularly on Newsnight and on sacred cow-burgering panels. Btw I think I may have given you that quote re ‘no time yet always do it twice’ – from my time as a consultant working with Lucas management-and where are they now??

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