Was the British government’s decision to embrace austerity in the wake of the global financial crisis the right policy? Yes, claims economist Kenneth Rogoff in a much-discussed recent commentary.
Rogoff argues that while, in hindsight, the British government should have borrowed more, at the time there was a real danger that the UK would go the way of Greece. On this view, British Chancellor of the Exchequer George Osborne turns out 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 UK’s credit performance has been far from credible.
He mentions the 1932 default on the World War I debt owed to the US, the debts accumulated after World War II and the UK’s “serial dependence on IMF bailouts from the mid-1950s until the mid-1970s.”
What Rogoff’s analysis lacks is the context in which these supposed offenses were committed. The 1932 default on Britain’s World War I loans from the US 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 10 years, suspending debt service only in the depth of the Great Depression.
Rogoff’s discussion about the debts accumulated after World War II 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 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-1950s to the mid-1970s, 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 greenback, causing the Bank of England to sell its US dollar reserves to defend the fixed exchange rate. As its reserves drained away, then-British 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 the US’ unwillingness to provide support. Furthermore, then-US president Dwight Eisenhower went so far as to use the US’ 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, former chancellor of the exchequer Denis Healey revealed that the Public Sector Borrowing Requirement had been grossly overestimated in the 1970s and that, had he had the right figures, the UK would never have needed a loan. According to him, the British Treasury even failed to recognize that the UK would have a tax surplus.