Soon after the collapse of the Lehman Brothers and the onset of the Great Recession, many people in the public arena began arguing for a Keynesian stimulus to get economies out of trouble. Gordon Brown even tried to engineer a global reflation package at the G20 summit in London in 2009. Promises were made but when the leaders got back home, they all retrenched.
Since the G8 Finance Ministers? summit in early 2010 in Canada, the main tactic adopted has been deflation. The enthusiasm for Keynesian policies heralded by my friend Lord Robert Skidelsky in his book ?Keynes : Return of the Master? can now be seen to have been dissipated. Keynes?s return like Mark Twain?s death has been much exaggerated. In the US, Obama has been locked in a deathly struggle with Congress and the outcome has been sequestration, which is beginning to trim the budget deficit albeit by use of uncoordinated cuts. Even while the battle for the debt ceiling and the budget goes on in the US, the urgency of the matter is gone by the simple device of a drastic cut.
The big political divide in the UK has been around George Osborne?s plan to cut deficit within one Parliament. I advocated such a strategy before the 2010 election and urged it on both the parties. My party, still under Gordon Brown?s leadership, refused to take up the challenge. The battle, we were told, was between the Labour?s growth and investment policies and the Tories? cuts. The voters know the reality principle, saw the Greek drama on their TVs and opted for Osborne.
The Labour in opposition said that the cuts were too far and too fast. They argued for a Plan B, which, though not specific, involved borrowing immediately to help the economy grow and hoped that debt would come down in the medium run. Ed Balls, the Shadow Chancellor, argued this most forcefully for three years. But most recently, Ed Miliband, the leader of the Labour party and Ed Balls have come to the conclusion that, if elected, the Labour party has no option but to continue cutting.
Hopefully, they would do it more humanely and raise more taxes. But the agreement is complete. There is no Plan B. There is only austerity till the deficit is eliminated and then the battle will continue to get the debt down. Across the eurozone, for its own special reasons (i.e. a strongly deflationary monetary arrangement), there is no question of adopting any Keynesian fiscal nostrums.
This is as serious a counter-revolution as I have witnessed over the last 50 years of learning and teaching economics. As far as the ruling parties in the developed economies are concerned, no one is Keynesian any longer. Fiscal policy will not be an actively used instrument in the near future, regardless of whether the government in power is conservative as in Germany and the UK or socialist as in France. We may continue to use Keynes?s language, even his grammar, but not his story.
What follows from this is the shrinking of the state. Here again, it is quite possible that when we finally come out of recession and resume growth at whatever speed we can manage, we may wish to restore some of the cuts to the welfare state. But that is unlikely. Income growth will be below the 1992-2007 norm. It will be at most 2-2.5% for most developed countries. With an ageing population, the expenditure on health and social care will demand a larger share of public spending. From any where between 45% and 55% as of now, the share of the government in GDP is likely to fall to 35-45%. The younger generation will have clear signals that they will have to be more self-sufficient than their parents. They already know that they will have a longer working life and measlier pensions.
Over the second half of the twentieth century, thanks to more or less continuous full employment and reasonable growth despite some adverse effect of the 1973 oil shock, welfare states expanded everywhere. Old entitlements were enhanced and new ones were added. From pre-school children and people with disability, the state began providing for citizens of all ages and almost all income levels since means testing was an anathema. In the UK, the coalition government has just fixed a ceiling on welfare entitlements at ?500 per week per household or ?26,000 per annum. Howls of anguish have gone up from across the Left liberal quarters. But it was pointed out that a household worker paying tax would have to earn ?32,000 to get as much after tax.
Apply that principle across the board and each entitlement is going to be scrutinised. The task of keeping the really necessary and progressive entitlements and cutting the rest will not be easy either economically or politically. But Western democratic politics will never be the same again. Bolshevism died within the twentieth century defeated by its own inefficiencies. The Keynes-Beveridge state is headed the same way.
The author is a prominent economist and Labour peer