The British Conservative Party, led by David Cameron, swept to a surprisingly robust victory this week, securing an overall majority of parliamentary seats and a large advantage in total votes over the Labour Party at a time when polls indicated that neither was remotely likely.
For Americans who have followed British politics primarily through the lens of American Keynesians complaining that Cameron's austerity policies destroyed the British economy, the results may come as a bit of a shock. Is the UK economy actually doing great? Was Paul Krugman wrong about everything?
The truth is more complicated than that. Team Austerity didn't do as well as a superficial read of the returns would suggest — the UK economy is in some ways struggling, the austerity question itself was considerably more complicated than the US media debate about it suggested, and fundamentally the biggest issue in the UK economy has nothing at all to do with austerity or overspending.
1) Cameron triumphed, but his coalition flopped
To set the table, it's important to understand what actually happened in the 2015 election. Back in 2010, Cameron's Conservative Party scored 36 percent of the vote and 306 seats in Parliament. That made it by far the largest party, but left it short of a majority. Rather than lead a minority government that would have to try to cobble together majorities on a case-by-case basis, Cameron formed a coalition with the third-place Liberal Democrats — a centrist party that had won 23 percent of the vote and 57 seats.
In 2015, the Conservatives won 37 percent of the vote, and the Liberal Democrats won 8 percent.
The total vote count of the austerity coalition, in other words, collapsed. And the popularity of Labour rose by a slightly larger amount than the popularity of the Conservatives.
The unpopularity of the austerity coalition is precisely what makes the defeat so crushing for Labour. People were not in love with the incumbent government, and the opposition had a clear chance to take over. But rather than win the votes of the disaffected, Labour watched opposition scatter — with votes heading to regional separatist parties, to the UK Independence Party, and to basically everywhere except the main opposition party.
2) The UK economy struggled badly in Cameron's first years
In 2010 through 2013, the overall UK economy really was performing quite poorly. These were hardly the best of times in the United States, but our economy was clearly growing. The UK, having crashed massively and then bounced back under Gordon Brown, witnessed a slowdown and a prolonged period during which total GDP remained below its pre-crisis level. But things began to pick up in the subsequent years.
Recent UK economic performance hasn't been stellar, but it's been totally fine — good enough for Cameron to hang on to those who supported him in 2010. But note that the UK continues to lag well behind the US in its recovery. Most research indicates that voters care more about rates of change than absolute levels, and Cameron's win seems to confirm that.
3) UK austerity was front-loaded
The coalition's controversial argument was that the British budget deficit needed to be reduced right away, rather than leaving the work of fiscal consolidation to come some time after economic recovery was underway.
This meant that the austerity mostly happened in the early years of Cameron's government. That's the centerpiece of Paul Krugman's explanation for the good years — they happened because austerity was largely over.
4) The UK has had a jobs boom
But while UK GDP growth went from bad to okay, UK employment growth has actually been extremely robust.
Not only has the unemployment rate fallen (as in the US), but the total number of people employed has soared as participation in the labor force has increased. A fair amount of this has to do with the coalition's policies, which have not simply been austere (i.e., focused on cutting the budget deficit) but are specifically focused on cutting social assistance spending and thereby encouraging people to go out and accept low-paid jobs.
The interesting macroeconomic achievement here is that the UK economy has been able to absorb all these additional workers despite mediocre growth.
5) Monetary policy has been expansionary
In the UK, as in the United States, the central bank has attempted to boost the economy with rounds of quantitative easing.
Unlike in the United States, this expansionary stance has including willingness to run an inflation rate of more than 2 percent for a period of years. This had the effect of substantially driving down average real wages, which helped a bunch of new workers find jobs amid a slumping economy.
6) The big austerity debate is about the past
Regardless of what you think of David Cameron, it looks clear that the United Kingdom is not currently in a severe labor market recession. That means that on a forward-looking basis, there are no real grounds for an ongoing austerity debate.
The real debate concerns the past. Cameron and his coalition partner Nick Clegg say that had they not moved to swift fiscal consolidation in the past, the United Kingdom would have been at risk of a Greek-style financial market panic and total meltdown.
It is difficult, in practice, to see how this would have happened. A loss of investor confidence in the fiscal position of the government would have resulted in a falling value of the pound and an expansion/inflationary monetary environment. A falling pound and an expansionary/inflationary monetary environment are exactly what the UK got under austerity. On the other hand, the success of the Bank of England in achieving an expansionary monetary environment in the context of fiscal austerity suggests that fears of austerity crushing the economy were also somewhat misplaced.
Austerity was neither necessary to avoid a meltdown nor sufficient to wreck the labor market. It was simply a policy choice to emphasize small government, less spending, and more employment in the private service sector rather than a more expansive welfare state with more public sector employment.
7) Britain's big economic challenge is housing
The current economic challenge facing the UK, then, is not unemployment but low wages and low productivity. How to increase wages and productivity is, in general, a very deep and difficult economic policy question. But in the specific case of the United Kingdom, it's actually relatively simple.
You see, in the UK productivity is massively higher in greater London and the nearby Southeast than anywhere else in the country:
If more people moved from the low-productivity regions to London and the Southeast, productivity and wages would rise.
So why don't they? Well, as a recent Center for Economic Policy analysis explained, "In 2014, UK house prices per square metre were the second highest in the world (topped only by Monaco), with especially high valuations in London and the South East. New houses are about 40% smaller than in similarly densely populated European countries."
This is because it is very difficult to get permission to build new houses in these high-cost areas: "The UK's planning system is the main cause of the affordability crisis, especially in London and the South East."
If the UK revised its planning rules to allow for more construction in the most expensive areas, real wages would increase through three mechanisms:
- Construction jobs pay more than service sector jobs.
- Cheaper houses would increase real wages by lowering the cost of living.
- New arrivals to London and the Southeast would become more productive.
This agenda of housing liberalization was not on the agenda of any major party in the 2015 election and appears very unlikely. But productivity has become the main problem in the UK economy, and housing reform is the key to unlocking it.