Was the British government’s decision to embrace austerity in the wake of the global financial crisis the right policy, after all? Yes, claims the economist Kenneth Rogoff in a much-discussed recent commentary. Rogoff argues that while, in hindsight, the government should have borrowed more, at the time there was a real danger that Britain would go the way of Greece. So Chancellor of the Exchequer George Osborne turns out, on this view, to be a hero of global finance.
To show that there was a real threat of capital flight, Rogoff uses historical cases to demonstrate that the United Kingdom’s credit performance has been far from credible. He mentions the 1932 default on its World War I debt owed to the United States, the debts accumulated after World War II, and the UK’s “serial dependence on International Monetary Fund bailouts from the mid-1950’s until the mid-1970’s.”
What Rogoff’s analysis lacks is the context in which these supposed offenses were committed. The 1932 default on Britain’s WWI loans from America remains the largest blemish on the UK’s debt history, but the background is crucial. The world emerged from the Great War in the shadow of a mountain of debt that the victorious Allies owed to one another (the US being the only net creditor), and by the losers to the victors. John Maynard Keynes predicted accurately that all of these debts would end up in default.
The UK was the only country that made an effort to pay. Having failed to collect what other countries owed it, Britain continued to pay the US for ten years, suspending debt service only in the depth of the Great Depression.
Rogoff’s discussion about the debts accumulated after WWII is beside the point. It is neither here nor there to claim that “had the UK not used a labyrinth of rules and regulations to hold nominal interest rates on debt below inflation, its debt-to-GDP ratio might have risen over the period 1945-1955 instead of falling dramatically.” The fact is that the UK did manage to reduce its debt using a series of policies, including encouragement of economic growth.
As for the UK’s “serial dependence” on the IMF from the mid-1950’s to the mid-1970’s, there were actually only two episodes: the 1956 bailout during the Suez crisis and the 1976 bailout that preceded the winter of discontent when strikes in many essential industries – even the dead went unburied – practically brought the country to its knees. (It hardly needs stating that borrowing money from the IMF is not a default.)
In 1956, the UK was facing a speculative attack in the midst of the Suez crisis. The country was running a current-account surplus, but the pound was slipping against the dollar, causing the Bank of England to sell its dollar reserves to defend the fixed exchange rate. As its reserves drained away, Prime Minister Anthony Eden was forced to appeal for help, first to the US and then to the IMF.
The IMF’s involvement was necessitated only by America’s unwillingness to provide support. Furthermore, US President Dwight Eisenhower went so far as to use America’s clout within the IMF to force Eden to withdraw British troops from Egypt in exchange for the loan.
The reality of the 1976 bailout is even more complicated. In the aftermath of the crisis, Chancellor of the Exchequer Denis Healey revealed that the Public Sector Borrowing Requirement had been grossly overestimated in the 1970’s, and that, had he had the right figures, the UK would never have needed a loan. According to him, the Treasury even failed to recognize that the UK would have a tax surplus.
Of course, all of this had drastic implications for the economy. Tony Benn, a Labour cabinet minister in the 1970’s, later revealed that the “winter of discontent,” which ushered in a Tory government at the end of the decade, had been caused by the severe cuts in public expenditure demanded by the IMF: “Why did we have the winter of discontent? Because in 1976, the IMF said to the cabinet, ‘You cut four billion pounds off your public expenditure or we will destroy the value of the pound sterling.’”
There is little evidence for Rogoff’s implicit assumption that investors’ decisions today are driven by the government’s handling of its debt in the past. The number of defaults is largely irrelevant when it comes to a country like the UK, which is politically stable, carries significant economic weight, and has an independent central bank.
Consider Germany, the “biggest debt transgressor of the twentieth century,” according to the economic historian Albrecht Ritschl. In the table on page 99 of their book This Time is Different, Rogoff and his co-author, Carmen Reinhart, show that Germany experienced eight debt defaults and/or restructurings from 1800 to 2008. There were also the two defaults through inflation in 1920 and 1923. And yet today Germany is Europe’s economic hegemon, laying down the law to miscreants like Greece.
The truth is that a country’s past failures do not influence investors if its current institutions and economic policies are sound. That was clearly the case when Osborne and his colleagues opted for austerity.