This is what happened the last time cuts were so drastic


9:10 am - October 18th 2010

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contribution by Adam White

George Osborne will finally be announcing details of the Coalition’s plans to drastically cut public spending this week, in what the news has interestingly (and correctly) labelled “the largest reduction to public expenditure to public spending since the ‘Geddes Axe’”.

Even Krishan Guru-Murthy at Channel 4 calls them, “the biggest cuts since the twenties”.

So let’s shed some light on that period of British economic history and see the consequences of those cuts.

In the early 1918 after the end of the First World War, the Liberal-Conservative Coalition set about reducing Britain’s large public debt, in face of what was already a severe economic crisis, by embarking on a large reduction to public expenditure. Sound familiar?

The results were devastating, as the table below clearly shows (hat tip to Victoria Chick for the data);

The first round of cuts led to contraction peaking at -8.7%, with an unemployment rate of 6%. By 1921 we see unemployment reach a massive 16.9%, followed by a jump in growth the following year, before it starts to contract again.

The most telling thing about this is the increase in the public debt over this period, from 114% of GDP, to 180% of GDP.

What economists refer to as ‘automatic stabilisers’, such as drop in tax receipts and increase in benefit payments, pushed borrowing up during a downturn, as growth slowed and unemployment rose.

If it is a ‘moral duty’ to reduce the size of a governments debt, then is it justified to leave the future genersations we seem so keen to protect from debt, with a smaller economy, in the pursuit of completing this moral duty? And is massive unemployment a price worth paying?

The Chancellor is putting all his hopes into a surge of private sector job creation, to offset the jobs lost in the public sector. In some part this will be true, but only in a small percentage, as some public sector jobs are transferred directly into the private sector, as opposed to being cut altogether.

Lastly, answer me this: when was the last point in British economic history that public sector retrenchment led to private sector job creation, whilst the domestic private sector was de-levereging (paying down its own debts), and growth slowing amongst our key trading partners?

It’s true that our economy has changed massively since the 1920s. But the same economic rules still apply.


cross-posted from Though Cowards Flinch

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Reader comments


For goodness’ sake, public spending is returning to 2006 levels. You lot make it sound like we’re going back to the fourteenth century.

At long last, a tiny measure of fiscal responsibility is coming. Visualise and tolerate.

What happened to the economy after we had to go to the IMF in 1976?

There is very little comparison between past cuts and future requirements. Circumstances are very different except we got them both from Labour administrations.

Umm, are you seriously comparing the circumstances of today with the aftermath of the first world war?

I should probabaly point out a small error here in reference to the table. I should have said the contraction *followed* the cutting, as opposed to “lead” to it. I would argue that it certainly did contribute towards the negative effects though, as there is a failry well established link between cuts and contraction/high unemployment when growth rates are low.

@Sean – I assume we’re insinuating that if we dont cut spending now, we may have to go to the IMF?

I thought these cuts were worse than anything that has gone before?

So how can you make, with any honesty, a comparison to when it was as bad?

Also, what Mr E said. 2006 was such a terrible year for middle class numpties requiring child benefit, after all.

It is a great experiment – we don’t know what will happen, and it is wrong for both sides not to recognise that there are risks on both sides!

Of course according to the earlier article, it looks like Lab are not going to suggest that we should have much less of a fiscal contraction, simply that the tax/spend balance should shift towards the tax side.

That’s probably the worst of both worlds since it will not make much near term macro difference, while hitting long term growth by structurally shrinking the private sector as a share of GDP.

The first round of cuts led to contraction peaking at -8.7%, with an unemployment rate of 6%. By 1921 we see unemployment reach a massive 16.9%, followed by a jump in growth the following year, before it starts to contract again.

Wait, you’re telling me that the demobilisation of the largest army Britain has ever fielded, involving conscription of all adult males, led to an increase in unemployment? Who’d have thought it? I mean, usually, when you decrease an fighting army of 3 and a half million to a peacetime one of 500,000 those 3 million people just disappear from the statistics. How odd that here they contributed to a rise in unemployment.

Also, when the Coalition propose reducing spending to less than 10% of GDP might be the time to worry.

@Tim – the point is that 5 years after the end of the war, with govt cutting back on expenditure, just over a tenth of the working population were still unemployed! There is absoloutely no reason that should ever be the case!

The main motivation of this post was to shed somne light on an episode the news are now referring to in comparrison to the current retrenchment.

If you support the chancellors position then try and find an answer for the main question at the bottom..

I can see the devastation caused by the inexplicable and cruel cuts between 1918 and 1919. Obviously the correct course would have been to maintain a million soldiers in Europe and keep the shell factories busy.Can’t imagine why we didn’t.

You leave one relevant statistic off your list – the government deficit, which peaked at 47% of GDP in 1917 and was still 34% in 1919. (Table 7). In other words, government borrowing, even after the hefty WW1 tax rises, was unsustainable – indeed at a level which makes our current situation look almost bearable, were it not for the fact that this is a global crisis – and anyway, we don’t have much manufacturing left to export our way out of trouble.

In 1918/19 Government expenditure was three times tax receipts. Currently it’s only about 35% more – 670bn spent vs 500bn tax coming in. Of course, we haven’t just fought a war with a million dead and 1.5m wounded – instead we’ve had 13 years during which we’ve seen ‘an end to boom and bust’.

@ Laban – you make an interesting point. major difference between now and the Lloyd-George government, is we no longer have the gold standard, as they did. I would say this made the above events much more difficult to avoid, especially, as you point out, spending was so much larger than government revenue.

Today however, the UK government faces no such constraint on its ability to send. And with so much excess capacity/so little growth, the argument for a continued government deficit is clear to me.

@ Laban – you make an interesting point. major difference between now and the Lloyd-George government, is we no longer have the gold standard, as they did. I would say this made the above events much more difficult to avoid, especially, as you point out, spending was so much larger than government revenue.

Nope. Britain suspended the Gold Standard in 1914, and only re-entered it in 1924.

Didn’t the same policies adopted in America prepare the way for the 1920s boom?

@Tim – youre right there, my bad. point is the thinking of the day still didnt shift to fit in with changed circumstances, and gold standard thinking still prevailed, as sadly, it does in many countries today.. So while they were temporarily free of operational spending constraints, they didnt seek to utilise them properly.

This was a side point though and I notice you still dont try and find an answer to the question though, asuming you do support the Chancellors position on the deficit?

It seems to me there’s a lot of energy going into defending a long gone government for its cuts programme in the early 1920s, when the reasons for the cuts are not actually the point of the article. The article is about what happened because of the cuts, not the particular circumstances in which they took place, and it simply suggests that there may be the same kind of effect this time around.

That doesn’t seem unreasonable to me, especially when there’s plenty of other evidence that attempts to balance budgets too quickly do tend to end badly: http://findarticles.com/p/articles/mi_m0254/is_n2_v55/ai_18262055/

@ Richard – was this not the point where America started to displace Britain as the largest foreign investor/creditor? Which was also a time where, what was formerly the major industrial powerhouse of the world, was crushed by the devestating effects of war..

This was a side point though and I notice you still dont try and find an answer to the question though, asuming you do support the Chancellors position on the deficit?

That’s because it’s a silly question. Public sector retrenchment is unlikely to ‘lead to’ private sector job creation, except in some limited ways (the reclassification of quangos as charities for example). But the point of reducing the size of the budget deficit is not to stimulate privaet sector job creation. Can you tell me the last time Britain ran a double digit budget deficit in peacetime?

Using the very specific circumstances of 1919-21 to make a point about unalterable economic law is just silly – was it Government spending that caused the decline in the UK textiles industry? Was the decline in shipbuilding perhaps mildly affected by the end of the war – and more dramatically in 1921 by the end of re-stocking? You just can’t print a graph of GDP/employment figures from 1921 and read them across to 2010.

Tim, as Ive already said that isnt what Im trying to do at all. I was simply explaining what the Geddes Axe was, and what followed it. On the data, there are more (very similar examples) that show gorwth and employment rartes taking a battering when govt reduces expenditure in uncertain times.

Supporters of the cuts, and the Chancellor himself, have repeatedly tried to insinuate that the cuts will, as he put it “create opportunities” in the private sector.

I fail to see how that is going to happen in the circumstances I have described, and so far, I have heard no one give a decent explanation to what you seem to think is a “silly question”.

Perhaps Osborne just thinks jobs are magically going to spring out of nowhere as IDS does?

You say the point of reducing the deficit is not to stimulate economic activity, so what is the point!?! And if that isnt the point, then why the hell are we continually obsessing over it, and trying to put at the centre of every economic discussion that is being had at the moment?

Getting the economy back to growth and people back to work should be the primary focus of all macro policy at the moment in my opinon, not the size of the budget deficit.

I would say we are in a worst position now because we don’t hardly make anything. If someone wants to set up a business, say like making computers then we all know this can be done cheaper in other countries so it is extreamly difficult to create private sector jobs for the vast unemployed.

Tim, as Ive already said that isnt what Im trying to do at all. I was simply explaining what the Geddes Axe was, and what followed it.

Well then lawks-a-mercy you need to do some more reading. The Geddes Axe wasn’t even thought of until 1921, and wasn’t implemented until 1922/3. If you want to explain its impact you might want a chart that goes beyond 1923. Jeepers.

You say the point of reducing the deficit is not to stimulate economic activity, so what is the point!?!

Well, actually I said that the point of reducing the deficit is not to stimulate private sector jobs creation – directly. The best way of doing this would be, of course, to cut National Insurance Employers contributions, thereby reducing the cost to employers of employing workers, without reducing wages. Unfortunately, as Liam Byrne so eloquently noted, there’s no money left.

The primary reason to reduce the deficit is a defensive one – to avoid economic disaster. That should be pretty uncontroversial – I’ve never come across anyone, even a Labour politician, who believes that the deficit can just be ignored and allowed to increase ad infinitum.

21. Luis Enrique

You say the point of reducing the deficit is not to stimulate economic activity, so what is the point!?!

lawks a mercy, how can you write on this subject and ask that question? What do you think happens eventually to a country whose government that runs a big deficit year after year?

It’s lawks-a-mercy season here on LibCon!

Tim, it seems we finally agree on something (kind of).

Though I think some big capital projects would be of use as well, I agree with you, cutting national insurance contributions could be of massive assistance. But I imagine youd disagree with me that maintaining a lot of current spending, and financing this NI cut by further increasing the deficit would be the way to go about it.

I completely disagree that the deficit is going to lead us to economic destruction, and that the time to “deal” with it will be when the economy is on the up again. We are not Greece, and the scaremongering that has largely refertenced the Greek situation just isnt valid in the UK in my opinion.

@Luis – two words again, “automatic stabilisers”! We expect deficits to increase naturally in face of downturn, as tax receipts decrease, and welfare payments increase. If the govt continues to fill in the spending gap with higher deficit spending during this period, once growth returns and employment rises, the deficit will automatically start to amend itself.

There is an interesting discussion taking place between some economists at the moment though, that questions wether or not governments with large welfare systems are even in control of the size of their budget deficits, or wether they are determined by market conditions.

Food for thought..

Adam – what’s this ‘excess capacity’ that you and Mervyn King keep going on about?

If you mean all those vast manufacturing plants running one shift when they could be running two or three, I don’t see any.

‘Excess capacity’ was a non-existent division being moved round the map in Gordon’s bunker. Now it’s King’s ostensible reason why printing money won’t produce inflation, even though the last lot just inflated asset (share) prices, made lots of money for the City, and produced imported goods and fuel inflation as sterling fell.

“Lastly, answer me this: when was the last point in British economic history that public sector retrenchment led to private sector job creation,”

Erm, 1946 to 1950 perhaps? Govt running budget surpluses and, umm, the demobilistation of the army and, umm, well, you know, exactly the opposite of what you’ve pointed out here.

And what was the major difference between post WWII and post WWI?

Yes, that’s right, the government were running budget surpluses. After WWII that is, when things went right.

So, the lesson here from our little foray into UK economic history is that? Well, how about, when you’re up shit creek, paddless, about to drown in the debt, umm, things work much better if the government starts running budget surpluses?

@Laban – I cant speak for Mervyn King, but Im referring to demand being insufficient to see any economic expansion. Mainly that available labour isnt being utilized to its full potential, which obviously leaves us with a situation where production, consumption and therefore growth isnt where it could be.

Going to the IMF? Erm, let’s not forget the other pieces of evidence – interest rates are lower now and our debt repayments are a lower percentage of GDP than during Thatcher years. And we have among the lowest GDP-National debt ratio in the western world.

@Tim W – Tim, you refer to surpluses of the post war period, as far as Im aware, the surplus Gordon Brown ran that ended around 2001 if Im correct, was the longest surplus recorded in the post war period? Id be glad to see any data you have to the contrary though..

Also, you only seem to have quoted a part of my question. What I want to know (and I genuinely do want to know the answer), is if private sector job creation has ever flourished along with fiscal retrenchment, whilst British companies were de-leveraging, and any factors were seriously inhibiting export based growth with our traditional trading partners. Im not aware of such an episode, but if someone can show me othrwise I would be content.

The only other thing I can think of that might stimulate such job creation at a time of retrenchment, would be if it started while the BoE was in a position to lower interest rates as a means of encouraging investment. Which obviously isnt an option available to us today.

@28 Adam White: “What I want to know (and I genuinely do want to know the answer), is if private sector job creation has ever flourished along with fiscal retrenchment, whilst British companies were de-leveraging, and any factors were seriously inhibiting export based growth with our traditional trading partners. Im not aware of such an episode, but if someone can show me othrwise I would be content.”

That it is a cracking good argument. It will suffice for the geeks. The reality is awful clauses (and I genuinely do want to know the answer) and endless sentences (unrecordable).

Adam White asks: :..if private sector job creation has ever flourished along with fiscal retrenchment, whilst British companies were de-leveraging, and any factors were seriously inhibiting export based growth with our traditional trading partners.”

What is your bet, Adam?

29. Adam White

‘ What I want to know (and I genuinely do want to know the answer), is if private sector job creation has ever flourished along with fiscal retrenchment, whilst British companies were de-leveraging, and any factors were seriously inhibiting export based growth with our traditional trading partners. ‘

Adam, there is an argument that can be made for what you are saying. However, using that period coming out of WW1 in the chart to make your point is silly. We were massively in debt to the Americans. Inflation was too high as were real wages and the whole of the 1920s was just a succession of monumental errors.

In answer to your question, it is impossible for the private sector to de-lever and at the same time the government to fiscally retrench unless there is a large increase in net exports. It is not strictly true that it is impossible because the government and the private sector can both de-lever at the same time but GDP growth and employment will fall. The government as they cut spending need the private sector to take on more debts (leverage) or net exports to increase. Companies could issue more equity rather than gear up with debt but that is trivial. It is difficult to see the household sector increasing their leverage so they are relying on the corporate sector to expand. That is why the central bank will conduct more QE to offset the government reducing spending. They want to pump more money into the economy and as a side effect reduce the exchange rate. A depreciated exchange rate will reduce imports and increase exports.

Richard,

Besides providing some background of the 20’s cuts, which the news are referring to now, I was keen to show the bit about increased debt/gdp ratios when spending is cut. Of which there is a trend far surpassing the 20s.

The question Ive asked towards the end has no relation to it, I accept that perhaps I wasnt clear about that.

Anyway, I see of no reason that companies cant delever whilst govt cutbacks, as long as the govt is still running a deficit? And as the deficit decreases I think that chances of leveraging will become less likely. I suppose only time will tell though.

Interesting to mention currency depreciation though. Ive been wondering for a while weather that is what Osborne is hoping for, with stimulating exports in mind. But the way the currency markets are at the moment with this little stand off between the US and China, putting all your eggs in that basket would be very unwise.

And I think QE will do little more than patch a few holes up, relying on it to help expand as govt tries to contract is unlikely. I suppose its essentially just swapping financial reserves between various sectors of the economy. But then again, we’re pretty much in unchartered territory on that front, so again we’ll just have to wait and see.

You are right the private sector can delever as long as the government have a deficit. However, how much they can delever is proportionate to how quickly the government cut spending. The corporate sector have no shortage of money at the moment. The liquidity ratio is at the highest it has been for forty years. However, the private sector financial surplus is the flip side of the government deficit. As the government reduces the deficit the private sector financial surplus also falls unless net exports increase. The government don’t actually want the corporate sector to delever. They want them to use their financial surplus to expand.

Imagine if the government decided not to run a deficit and tried to balance their accounts. The financial surplus of the deleveraging private sector would simultaneously disappear. Output would fall dramatically and unemployment would shoot up. It is the government deficit that allows the private sector to delever and pay down debts.

I have more faith in QE than you and although it is not a miracle cure it is effective. Stimulating exports is crucial for Mr Osborne. That is why he has the Foreign Office operating as a global super sales task force. There is nothing wrong with his export strategy in theory. However, his problem is our main trading partners are in Europe and their economies are depressed and they are all trying to follow the same strategy. After the Fed ease with more QE, the BoE will follow them. The hard money nutters at the ECB will be forced to ease or they will be crushed. Therefore, we should then see a rise in NGDP growth.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  2. drmaybe

    RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  3. Derek Bryant

    RT @libcon This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  4. Melissa Nicole Harry

    RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  5. Sarah Duff

    RT @libcon This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  6. Greg Sheppard

    http://liberalconspiracy.org/2010/10/18/this-is-what-happened-the-last-time-cuts-were-so-drastic/

  7. Richard Morris

    RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ : Food for thought.

  8. Labour in Cheltenham

    The biggest cuts since the 20's ahead – is history about to repeat what happened with the last Con-LibDem coalition? http://bit.ly/aaWaba

  9. Elly M

    RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  10. Katie R

    RT @kindjourneys: RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  11. Jackart

    More Insanity from Liberal Conspiacy. Economic data from 1918-1923 Whilst only mentioning THE GREAT WAR in passing. http://bit.ly/aaWaba

  12. Jackart

    More Insanity from Liberal Conspiacy. Economic data from 1918-1923 Whilst only mentioning THE GREAT WAR in passing. http://bit.ly/aaWaba

  13. Gordon Masterton

    RT @libcon: This is what happened the last time cuts were so drastic http://bit.ly/9ZpTlQ

  14. Naadir Jeewa

    Reading: This is what happened the last time cuts were so drastic: contribution by Adam White
    George Osborne will … http://bit.ly/doychR

  15. Nina

    This is what happened the last time cuts were so drastic | Liberal Conspiracy http://t.co/f0biT1D via @libcon

  16. Heather

    RT @aidanskinner: why what's about to happen would appear, on a historical basis, not just a bad idea but utterly counterproductive http://s.coop/4gp

  17. Countering the Coalition cuts: a myth-busting guide | Liberal Conspiracy

    [...] This is what happened in the 1930s – the last time the government tried to cut spending so drastically. [...]

  18. chrispydog

    See what happened last time Britain cut public expenditure this much. It's not pretty: http://tiny.cc/oroiw





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