Clarity of purpose is a virtue. But stubbornness doesn’t necessarily win any plaudits when more flexibility is appropriate. The shock tactics of Osbornomics have now been fully embraced. The message is clear: this Coalition is not for turning.
In the run up to the Election the Conservatives and the Liberal Democrats adopted distinctive positions on the best approach to cutting the fiscal deficit. Despite Nick Clegg’s apparent secret conversion to the Conservative position of early and deep cuts, the LibDem manifesto commitments were directed at cutting in 2011/12 and after, and the rhetoric around budget reductions was to proceed at a pace that would not endanger economic recovery.
In the face of another slew of data about poor economic prospects this week, it is worth revisiting the LibDems’ original position on this issue. It is increasingly looking the more plausible and prudent of the two. If that position could to have any traction on the direction of policy as we head towards CSR then some of the most serious negative impacts of the current strategy might be mitigated.
Each day we seem to receive a warning about the wisdom of the current strategy or new data that are read as indicating that the current strategy is having a serious negative impact in the short term. These warnings are not emerging from the usual suspects only. It isn’t all special pleading. The head of HSBC expressed concern that there was danger that governments were ‘cutting into the muscle’ of the western world. Commentators monitoring confidence, activity and employment trends in the private sector report a deteriorating picture. There are signs that the housing market is weakening sharply in advance of expected rises in unemployment. Talking about the economy in this way is in itself important.
One issue we face is that our understanding of the economy and how it will respond to the Coalition strategy is rather less well-founded than it might first appear. Macroeconomic policy is a matter of judgement rather than science, as anyone who has read the minutes of the Monetary Policy Committee will see only too clearly.
The sort of models used by the Treasury and others to estimate the impact of policy interventions struggle to account adequately for more qualitative factors like household confidence and expectations about the future. There is limited room for hopes and fears, the reactions of consumers to unknown but possibly negative events, the ‘animal spirits’ that Keynes considered fundamentally shape the fate of investment and the economy more generally. The economy is not a well-oiled and predictable machine to be finely tuned, it is a much more organic and irrational beast. One illustration of this point is the current puzzle of the absence of UK exports. Simple theory suggests that, other things equal, the recent depreciation of the pound should lead to increased demand for exports. But this hasn’t happened yet. No one is entirely sure why.
It is clear that qualitative factors relating to emotion and confidence are fundamentally important in understanding the current economic situation. Many households already find their circumstances deteriorating as a result of cuts that are in train – cancellation of private sector contracts with the public sector and grants to the voluntary sector. The narrative of the near future is tailor-made to undermine confidence: swingeing public sector job cuts, restrictions in benefits, generally very choppy economic waters. It is not surprising that many are fearful. That leads households to hunker down and reduces effective demand. Rational private sector suppliers trim their sails accordingly.
The Conservatives believe that an automatic and predictable private sector revival will over the medium term and more than compensate for the short term pain. They have yet to explain quite how such a revival will occur in a context where both domestic and overseas demand is weak. The private sector is unlikely to step in when it is not obvious that there is demand for its services from either private or public sector.
Contrary views range from the position that we should expect a prolonged depression, as suggested by the NIESR recently, to the position that the fiscal contraction, when its full impact begins to be felt in the autumn, will trigger a genuine double dip recession. If that happens then it will have been largely self-inflicted. A firm but less savage approach to the deficit could have achieved the same goal without losing the confidence (there’s that word again) of the markets and without threatening to plunge the economy into territory not visited since the 1930s. In fact, an approach very like the one the Liberal Democrats advocated in the first place.