Nick Clegg on the double-dip recession: “our answers are the right ones to repair the damage done”

Nick Clegg spoke this morning to the Institute of Directors, shortly after the announcement that the Office of National Statistics estimates that the economy contracted by 0.2% in the first three months of 2012 — a second quarter of shrinkage that officially means the UK is once again in recession. Here’s what he had to say:

As you may have heard, the first set of GDP figures for this year have just been released. And so, if I may, I would like to start by addressing what is disappointing news. The ONS’s preliminary estimate for Q1 GDP has shown a fall of 0.2%.

Many people, many of you, will now be asking what this means. I asked myself the same thing when I heard the figures too.

To answer that question, we need to step back for a moment. Step away from the clamour for panicked reactions, the inevitable calls for the government to lurch this way or that, to ask ourselves, quite simply, are the basic building blocks of our strategy right?

Pulling the country back from the brink by repairing the public finances.

Reforming our financial system to protect the taxpayer from future crises.

Rebalancing our economy away from its overreliance on one industry, financial services, in one city, London, so that growth is spread and prosperity shared.

These are not overnight projects.

We have undergone a profound trauma in our economy, the depth and breadth of which we are only just beginning to grasp.

By 2016 our economy is forecast to be 11% smaller than it would have been had the 2008 banking crisis not happened.

We’ve witnessed an unprecedented combination of events: financial collapse; an overleveraged housing market; staggering levels of public and private debt. So fixing the damage takes time and commitment.

Our task has been nothing less than to rescue, repair and reform the British economy as challenges continue to confront our major trading partner – the Eurozone. So there are no short cuts.

And we have to remember where we would have been had we not taken these difficult decisions.

Because of our action on the deficit we have kept the markets at bay while our neighbours have been picked off one by one. We’ve kept interest rates at record lows. Because we have stuck to our plan, the UK – the country which had the biggest budget deficit in any advanced economy, bigger than Greece, Portugal, Spain – will, by the end of this Parliament, have a deficit lower than the G7 average.

So, yes, this morning many people will have questions about what these figures means for the UK. But our answers are the right ones to repair the damage done.

Not easy, but right.

Tim Leunig, chief economist of liberal think-tank Centre Forum, was asked for his verdict on The Guardian’s Reality Check blog whether the eurozone crisis has caused the double-dip recession. Here’s what he said:

There’s very little you can say about that either way unless the ONS says that exports have collapsed. The construction industry is not a eurozone issue. If the eurozone had done better other sectors might have grown. If it’s construction it’s not really the austerity measures either – it’s not teachers losing jobs.

But it could be either indirectly – people not building extensions because they are suffering from their own exports to the eurozone falling, or because they lost their public sector job. But you can’t immediately point a finger either way and say it’s that.

It’s important to remember that the initial British GDP quarterly figures are hopelessly unreliable, they are quick, they involve guesswork. The Bank of England is very sceptical. Whether it’s plus 0.1 or minus 0.1 the economy is in the doldrums. Since the start of the recession Canada has got back to its previous peak, so has Germany and the US. They are all richer than they were. France is back to where it was. Japan’s is closer. Only Italy is worse. Within the G7 only Italy is doing worse than us. I mean heck. It’s not where you want to be.

The causes are a known unknown. What’s interesting is how we can get out of the problem. If you see the doctor and ask why you got cancer it’s not really relevant. We just want a cure. It’s the same with this. What we care about now is prognosis what can we do to get out of this. This isn’t a case of Ed Balls or George Osborne, plan A or plan B. There are lots of different historical precedences we can look at to get out of this. But it needs a change in course. You can say it’s the lack of a growth strategy that’s working. The government has a growth strategy. It isn’t working. The government believed austerity would reassure the economy. That’s not the reality.

* Stephen was Editor (and Co-Editor) of Liberal Democrat Voice from 2007 to 2015, and writes at The Collected Stephen Tall.

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63 Comments

  • LondonLiberal 25th Apr '12 - 1:54pm

    Tim’s comment rather suggests that Cleggy blaming foreigners and Labour for the total lack of growth isn’t actually true, then.

  • Paul Holmes 25th Apr '12 - 2:25pm

    Tim, not long before the 2010 election I attended a North Derbyshire Chamber of Commerce breakfast. A large proportion of the businesses there were involved in Construction -everything from ‘hands on’ through crane and scaffolding hire to architects and ranging from small local family firms to national companies. The general consensus was that they had been kept afloat from the 2008 financial crash through to 2010 by Public investment in schools, hospitals, roads and housing and that if this was heavily cut back, by whoever was in Government after the election, then they would suffer accordingly.

    So the Construction industry dip being a major part of the current quarter’s recession is not exactly unexpected and is not exactly divorced from Government policy. As we warned right up to polling day in 2010!

  • toryboysnevergrowup 25th Apr '12 - 2:27pm

    What will it take Clegg et al to realise that it is the deflationary policies of his government and those that the German government are forcing on members of the Eurozone that together are actually restricting growth and are actually doing precious little to reduce government deficits. This is all sounding very much like the 1920s and 30s where blind pursuit of economic dogma also created a prolonged depression.

  • Has anyone asked how many bad economic results it will take before policy is reconsidered>?

    There’s certainly a variety of views within the cabinet on the economy, I seem to recall Vince, pre May 2010, warning that Osborne’s plans were dubious…

  • Tony Greaves 25th Apr '12 - 2:35pm

    Paul is quite right. If the cause is the consgtruciton industry that is a direct result of the large cuts in public sector building projects – investment.

    This government like all others does not seem to understand the difference between capital and current spending. Borrowing for investment is not only sensible in a recession it is essential. Conflating it with borrowing to sustain current spending is ignorant and inexcusable.

    Put simply if a fall in construction projects is to blame for the double-dip recession, it is a direct result of government policies.

    Tony Greaves

  • mike cobley 25th Apr '12 - 2:36pm

    Quote – “But our answers are the right ones to repair the damage done. Not easy, but right.”

    Translation – “We haven’t dug a big enough hole yet. Keep digging!”

  • Nick Clegg in his speech on the economy to the LSE last September LSE speech stated the following:

    “..investment in infrastructure stimulates demand not overnight, but more quickly than many supply side measures. And it raises productivity well into the future too. Not just any infrastructure – we need to be clear about that. The previous Government took a kitchen sink approach: any and all capital spending constituted pro-growth investment. But that’s not true. Most capital spending is worthwhile. But it doesn’t all support long-term prosperity. You have to be ruthless, focusing on the investments that transform growth potential: transport, energy, digital communications. Roads and rail so manufacturers can transfer goods. Better broadband so small, high-tech companies can flourish. Renewable energy so low-carbon industry can too.
    If you modernise this kind of infrastructure you stimulate activity in the shorter term and you build systems high growth industries can use for years to come. Transport schemes announced in the Spending Review, for example, will deliver major boosts to growth. Like the Switch Island link road in Merseyside, where £20m of Government investment will generate 35 times that in economic benefits. Or increasing the capacity of the M62, which will generate over £1bn for GDP. Investments that will keep on giving. The kinds of investments the UK needs.”

    We have a national infrastructure plan that needs £500 billion of investment over the next decade. We need to build 400,000 houses a year for the next ten years just to satisfy demand. Yet public sector capital spending is being dramatically reduced. The construction sector is contracting, orders are falling, men and equipment are laid off and remain idle.

    The reason for these draconian cuts in public investment, it appears, is fear that interest rates will start to rise if borrowing is allowed to increase over and above current projections.

    Borrowing cannot be significantly reduced without a significant demand stimulus to boost confidence in the economy, by way of public investment in infrastructure. All that will happen is that we will be borrowing to fund a continuing current account deficit (non-capital spending), not reduced by trend growth, instead of borrowing to fund lasting infrastructure investment. Without economic growth, markets will lose confidence in the deficit reduction plan. The very thing that is feared, loss of market confidence, will come about as a result of absence of boldness in addressing the persistent weakness of demand in the economy.

  • toryboysnevergrowup 25th Apr '12 - 3:27pm

    There is a genuine point that this cannot all be blamed on the actions of the UK Government, I am afraid that they are falling in with the prevailing orthodoxy of the financial markets and the German Government which to all intents and purposes runs the Eurozone. My real problem is that Clegg appears to be unable to show the leadership to challenge the othodoxy – and the cat seems to have got the tongue of those such as Cable who used to know better, and was telling us before the election that the deficit should not be cut until growth had become established.

  • There is massive infrastructure investment in the railways. Crossrail tunnelling has just started – the biggest construction project in Europe.

    The problem isn’t in the public sector at all – there has been a big increase in public sector capital spending. It’s private sector housebuilding & small scale work that has contracted.

  • Alex Sabine 25th Apr '12 - 3:54pm

    Tony: If governments confined themselves to borrowing for investment purposes in economic downturns our public finances would certainly be in much better shape than they are!

    The construction data tends to be especially prone to subsequent correction by the ONS, but, as they point out, the adjustment would need to be considerable to nudge the economy back into positive growth.

    Clearly the cut in public investment has had a role here. In fact the coalition has actually marginally trimmed the plans inherited from Labour for large cash cuts in capital investment and shifted the balance a little – although insufficiently in my view – towards curtailing current spending (which is being held roughly constant in real terms). Labour planned to rely on capital cuts for a significantly greater proportion of their deficit reduction than the coalition is doing, while continuing to increase current spending but a lower rate than before.

    The ramp-up in capital investment in 2008-09 was accompanied by big discretionary increases in current spending as well; the capital increases were intended as a stimulus lasting around 18 months before they would be reversed, starting in 2010. (The current spending increases were due to the decision to maintain the 2007 Spending Review cash totals despite falling inflation and GDP.) Without this plan to reverse the capital spending boost the last government’s overall fiscal numbers would have had even less credibility.

    Most economists believe capital spending has larger beneficial multiplier effects for the economy as a whole; but it is the nature of capital spending that it is easier to cut than current spending, for governments and companies alike. It’s obviously easier to postpone building a new road than to cut wages. (Indeed that very flexibility is one of the reasons why capital spending is a more suitable candidate for fiscal stimulus than increased current spending, since the stimulus is designed to be temporary and therefore needs to be able to be withdrawn.)

    The problem with extending a ‘temporary’ stimulus almost indefinitely is that you can’t grow your way out of an 11% of GDP budget deficit on a tide of borrowed money. The debt dynamics are against you.

    And despite the opposition’s claims that the coalition’s fiscal plans are in tatters, the facts tell a different story. The deficit has come down from 11.1% of GDP in 2009-10 to (a still daunting) 8.3% of GDP in 2011-12. The structural deficit has come down from 8.9% of GDP to 6.4% of GDP over the same period.

    As the IFS said yesterday in their analysis of the public finance figures, the slippage compared to forecasts made a year ago (ie, before Osborne had to announce gloomier forecasts in the Autumn Statement) has been remarkably small given the disappointing economic performance: “Borrowing in 2011−12 is estimated to have been only £4 billion higher than forecast a year ago in the March 2011 Budget. This would be considered a small forecasting error even in normal times and this is therefore particularly small given current levels of uncertainty.

    Of course, this is small consolation to people who have lost their jobs or businesses that are struggling to survive in a bleak economic climate. But getting on top of an unsustainable debt build-up was never going to be a painless process, and international developments (mainly high commodity prices and the eurozone crisis) have only made it harder.

    A credible deficit reduction plan certainly isn’t a sufficient condition of economic recovery, but it is a necessary one – which is presumably why very few business organisations or international bodies are calling on the government to reverse course. I agree it needs to do more to nurture confidence and promote growth, but a deliberate increase in borrowing from the present high level will, at best, just ‘kick the can down the road’ for a couple of quarters, while making us more vulnerable to a negative reaction in the gilts market.

    Austerity isn’t enough; but that doesn’t make it any less necessary. Those calling for a Plan B should be looking for something more imaginative and plausible than the short-term palliatives they habitually offer.

  • Alex,

    “the problem with extending a ‘temporary’ stimulus almost indefinitely is that you can’t grow your way out of an 11% of GDP budget deficit on a tide of borrowed money. The debt dynamics are against you.”

    It is not a temporary or indefinite stimulus that is required. It is sufficient public sector infrastructure spending into the economy to maintain demand and offset the planned reductions in current expenditures through to 2017.

    The growth forecasts for the next few years are heavily dependent on robust growth in consumption – household spending. That increased consumption is not projected to come from growth in real wages but rather dramatic increases in consumer debt. This is a leap of faith by any measure.

    Current planned capital expenditure is in the region of £10 billion to £15 billion per year. This needs to be ramped up to £50 billion+ over the next five years. The spending needs to be targeted, as Nick Clegg points out, not on social infrastructure, but on economic infrastructure that can generate returns into the future.

    The multiplier effects should be sufficient to bring unemployment back to the 1.6 million level, obtaining prior to the recession. This is how growth in consumption/household spending will be resumed and the structural deficit reduction and borrowing targets ultimately achieved.

    Negative reaction in the gilt markets will come from continued failure to initiate a sustained recovery and annual downward revision of growth targets.

  • Alex Sabine 25th Apr '12 - 4:30pm

    Just for the avoidance of doubt, of course I don’t think that austerity is always appropriate in all circumstances. For several countries in the eurozone now it probably is too ‘front-loaded’ (ie too severe in the near term) and too pro-cyclical, given that there is no possibility of adjusting relative costs through internal currency revaluation.

    But with the exception of Germany this has happened where countries have lost the confidence of their creditors and been forced into panic action by spiralling bond yields and deteriorating debt dynamics. This only underscores the importance of having a credible medium-term plan to put the finances in order. Better to keep control of your destiny than to put yourself at the mercy of the markets and be forced into much deeper austerity over a much shorter timescale.

    The depressing spiral that countries like Greece and Spain are caught in is, of course, also a reflection of the much deeper – and perhaps insoluble – structural problem that the eurozone simply isn’t what economists call an ‘optimal currency area’ or anything like it.

    It also reflects the fact that, while they have been announcing tough and unpopular austerity budgets, in general they haven’t been addressing the underlying causes of their high unemployment and steady loss of competitiveness relative to their stronger eurozone neighbours (high unit labour costs and social charges, rigid labour markets etc). And their pension systems (particularly but not only in the public sector) are still a lethal danger to their future public finances.

    Their measures have been crisis-driven rather than addressing the long-term challenges. To believe that the likes of Francois Hollande or Ed Balls could paper over these cracks with a renewed bout of stimulus spending doesn’t bear serious scrutiny.

  • Mike Barnes 25th Apr '12 - 4:34pm

    “The causes are a known unknown.” Err no, the causes are known. They are David Cameron and George Osborne.

  • These sorts of policies have never worked anywhere ever. It’s that simple. Sure Germany are adding to Europe’s woes, but the fact remains that there was growth in this economy in 2010 and this chancellor has stalled it. The other thing is that great claim of this coalition was that it was formed to rescue the nation from further financial collapse. It’s achieved exactly nothing. On top of which it has also pretty much killed the lib Dem’s as a political force. for decades, It’s terribly sad.

  • Alex Sabine 25th Apr '12 - 5:19pm

    Joe: There is almost no planned reduction in current expenditure (even in real, inflation-adjusted terms) over this Parliament. The average real-terms cuts are 0.3% per year, and there has been no cut at all in real-terms current spending thus far. (In cash terms current spending is forecast to rise from £629 billion in 2010-11 to £686 billion by the end of the Parliament and £709 billion in 2016-17.)

    Almost the entire real-terms spending squeeze is coming through capital cuts; as I said, it is questionable whether this gets the balance right, although it is true that capital investment was ramped up sharply in 2008-09 and was at historically high levels before the recent cutbacks.

    As regards the macro strategy, I’m not pretending that these things are black and white. Economic policy is inescapably a matter of judgement and not blind adherence to rules, and clearly there is a balance of risks that need to be weighed up when deciding on the timing and pace of tackling a structural deficit.

    At the current economic conjuncture that balance is particularly finely poised: It is a question of whether the likely demand benefits of a fiscal stimulus (or relaxing the current austerity plans) are sufficiently large to justify taking a risk with exceptionally jittery bond markets and interest rates.

    This is not an insignificant risk: Over the next five years the UK government is expecting to have to issue £740 billion of new debt in order to cover its forecast borrowings and to refinance expected gilt redemptions. Even a small increase in the interest rates at which this debt could be financed would jeopardise the sustainability of the public finances without further policy tightening, and force further cuts to programmes to service the debt interest bill.

    Of course you are right that a persistently weak economy is itself a threat to the fiscal plans, such that (in theory) the bond markets might welcome a stimulus as making delivery of the fiscal plans more rather than less likely. In that scenario a fiscal loosening could even be a ‘win win’ rather than a balance of risks.

    But there is little evidence that investors are currently taking that view; and on the basis of the figures I supplied in my earlier post, it would be irrational of them to do so, since the deficit is coming down only slightly slower than forecast despite the economic headwinds and the consequent weaker GDP performance.

    I do concede that this situation could change, and that’s why – despite the government’s refusal to countenance a Plan B or A+ or whatever – I think it would be wiser to set out in advance of any crisis circumstances in which the profile of the fiscal consolidation (in terms of pace and capital/current balance) might be altered and any increase in short-term borrowing fully recouped through additional cuts later. This would ensure maximum market credibility while still giving the government a certain amount of room for manoeuvre. However, I’d argue for this not as the basis for changing current plans now, but as a precaution against a sharp deterioration in the eurozone situation over the next year or so.

  • Alex Sabine 25th Apr '12 - 5:38pm

    Also on one other factual point, planned capital spending this year is not £10-15 billion this year but £28 billion according to the OBR’s budget forecast (£49 billion gross, less £21 billion of depreciation).

  • Richard Dean 25th Apr '12 - 5:42pm

    If Germany and France are back on track, and the US and Japan too, doesn’t that indicate that our problems are NOT caused by reduced demand in export markets? It’s not Europe that’s causing us grief, it”s us ourselves!

  • Paul Krugman makes his feeling clear
    http://krugman.blogs.nytimes.com/2012/04/25/camerons-remarkable-achievement/

    The Coalition have messed up the economic recovery which Brown and Darling had put in place. I think, instead of attacking Labour, this blog should start to hold its own leadership to account.

  • Alex,

    I think a lot of the planned reductions in departmental spending are in social infrastructure, military spending etc., (capital spending on hospitals, schools etc). Granted this is not current spending, but nonetheless withdraws significant demand from the economy and can be usfully replaced with needed investment in economic infrastructure.

    It was only two months ago that Moody’s put the UK on a negative credit watch due to worsening growth prospects.

    The PBSR is a fine balancing act as you say, but I would rather focus on what is within our own control, than relying on a favourable soverign risk premia (i.e. we might be in poor financial shape, but not as bad as some others) to keep interest rates at historically low levels.

  • Bill le Breton 25th Apr '12 - 6:25pm

    Tim is quoted as writing, ‘But it needs a change in course. You can say it’s the lack of a growth strategy that’s working. The government has a growth strategy. It isn’t working. The government believed austerity would reassure the economy. That’s not the reality.’

    That’s a jaw dropper, coming from him. I imagine Nick Clegg with his head in a cold towel.
    Some common and dangerous memes have developed over the last few years:

    1. ‘Expansionary fiscal contraction’. It is very difficult to bring down a deficit when one or more of the other elements of the economy is trying to lend/or pay down debt. Let’s use their savings to good effect on public works.

    2. ‘We have run out of money’ – a currency issuer cannot run out of money – it can hit problems with inflation, but we are nowhere near this point. We should mix the financing of our public works with a mixture of government bills (to use the savings from other sectors) and credit expansion (i.e. QE for publically commissioned investment).

    3. ‘There are no more monetary policy options available’ – monetary policy is not wholly restricted to interest rates. QE for employment tax reductions and public works (not for non-bank financial concerns).

    4. ‘Our debts will be a burden on our grandchildren’ – the legacy we leave our grandchildren is wealth and, through wealth, time or lack of wealth and lack of time. We must build the necessary infrastructure as our true legacy – a legacy not of endless work and acquisition, but of time, mental capacity, culture, ease, harmony.

    5. ‘There is no alternative’ – there is. That’s it, ‘THERE IS’.
    These memes have to be exposed for the fictions that they are. There has to be a sense of common purpose based on a plan (a New Deal) supported by economic stimulus both fiscal and monetary.

    We are a union of countries with huge potential founded in our physical, financial, cultural and personal capacities. This has to be communicated clearly and with confidence, to engage our united population in this purpose. This is what true leadership is about.

    When we believe that we can achieve, we will achieve. Borrowing from FDR again, ‘we have nothing to fear but fear itself. And those dangerous fictions, which destroy our liberty, our potential our chances in life.

  • Richard Dean 25th Apr '12 - 6:34pm

    It is certainly illuminating to learn that the Deputy PM is “only just beginning to grasp” the depth and breadth of the profound trauma in our economy

  • Alex,

    “Also on one other factual point, planned capital spending this year is not £10-15 billion this year but £28 billion according to the OBR’s budget forecast (£49 billion gross, less £21 billion of depreciation).”

    I can,t tell from the OBR stats how much of the capital expenditure is on new economic infrastructure (as per the National Infrastructure Plan) as against long term maintenance/social infrastructure etc., but I am guessing in the region of a net £10 to £15 billion per year.

  • Bill le Breton 25th Apr '12 - 6:59pm

    Richard your quotation made me read the speech again. It refreshed my memory of why our Leader annoys me so.

    On the one hand he says sensibly, ‘To answer that question, we need to step back for a moment. Step away from the clamour for panicked reactions, the inevitable calls for the government to lurch this way or that, to ask ourselves, quite simply, are the basic building blocks of our strategy right?

    But then, without pausing for breathe immediately lists proposed actions. Where was the reflection, the step back? There is no sense of humility, not a trace of self-doubt.

    I think he should get on a bicycle and ride north to begin with. When he reaches Midlothian he should dismount, put on some trainers and begin walking, and listening and walking some more and reflecting before meeting others and listening some more.

    He should make his way gradually through our countries engaging with people by respectfully listening. At might he should mull over what he has heard. Gradually he may even come to a conclusion or two.

    Having been so wrong he can’t expect to get things right without such a period of penance and reflection.

    Nor is such an idea as daft as it may read!

  • Bill Le Breton.

    “These memes have to be exposed for the fictions that they are. There has to be a sense of common purpose based on a plan (a New Deal) supported by economic stimulus both fiscal and monetary.”

    That’s quite a radical plan, Bill.

    There are two obstacles to be overcome:

    1. Jim Callaghan’s warning in 1976 – “We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”

    Callaghan was dealing with wage/price inflationary spiral, an industrial relations crisis and runaway expansion in consumer credit. What we are faced with today is a debt deflation problem in the private sector. This requires counter-cyclical measures by the government i.e. above target inflation and expansion of the PSBR until the output gap has been substantially closed.

    2. Milton Friedman’s dictum: “‘Inflation is always and everywhere a monetary phenomenon.”

    Applying Quantative easing directly for tax reductions and public works would be a highly unorthodox approach that carries the risk of spooking gilt markets as a result. What we have seen however, is 325 billion of QE filtered through the commercial banking system and finding its way to the financing of much of the new government debt issued over the past few years.

    With interest on ten year gilts at 2.13%, now would seem a good time to start acquiring the funds needed to carry through the national infrastructure plan. If more QE is needed to support government debt issues, then as long as long term inflationary expectations remain low, this should not present an undue problem.

    The corollary to this is that the time will come when fiscal and monetary stimulus will need to be reversed. When the economy is back to trend growth and near capacity, investment spending will need to be curtailed and a budget surplus run for a time. As inflationary expectations begin to pick up, the B of E will need to start selling it’s gilt holdings back into the market to deflate the money supply and take monetary inflation out of the system.

  • Simon McGrath 25th Apr '12 - 10:13pm

    We are already carrying out a Keynesian strategy financed by borrowing of nearly £500bn over the course of this Parliament. On the Treasury figures Total Managed Expenditure was £582bn in 2007-2008, rising to £710bn in 2011-12 and forecast to be £743.6bn in 2014-2015.
    Doesnt seem to be working

  • Simon,

    you are absolutely right about the level of borrowing support for government spending in this parliament. A good part of it is made up of the automatic stabilizers.

    Even with this level of support, Vince Cable gave quite a stark assessment last November telling the Metro the economy could stagnate for up to three years and, in a ‘doomsday scenario’, it may be ten.

    He said: ‘Until recently, the common view was the recession would not last too long but I think we can now see signs that it might be really quite protracted.

    ‘When I talk about recession, I’m talking about it not in the economic sense – two consecutive quarters of negative growth – but as most people see it, with job losses, house repossessions and a lack of consumer spending. The doomsday scenario would be that we finish up like Japan did, with ten years of stagnation.’

    Mr Cable suggested local authorities should buy up stock from struggling building companies while prices are cheap and mortgage lenders should offer to buy back part of homes.

  • “….by the end of this Parliament, have a deficit lower than the G7 average.”

    Only 18 months ago the target was zero. I predict next year Mr Clegg will be saying “by the end of this Parliament, have a deficit only a little bit higher than when we came to power”.

    When Mr Cable said “We have no coherent plan” he was spot on. To get the economy moving it’ll take far more imagination and ambition than the Coalition have so far shown. The pointless Regional Growth Fund and probably the Green Bank too are insignificant to a £1.4 Trillion economy.

  • Alex Sabine 26th Apr '12 - 1:43am

    Joe,

    1. Agree that there has been some withdrawal of demand already: This has been via net tax increases (NI and especially VAT) and capital spending cuts, not current spending cuts. Indeed, so far there has been a heavy reliance on tax rises rather than spending cuts due to the decision to front-load the VAT increase and current spending continuing to rise in real terms.

    2. Agree with the contrast you draw between inflationary spiral in 1976 – in which, as Callaghan (/Peter Jay) rightly warned, demand stimulus would simply lead to higher prices and eventually to higher unemployment too – and the debt-deflation and corporate deleveraging situation that we are faced with now.

    The government and Bank of England are clearly aware of this distinction too, which is why the policy response has been spectacularly different, with monetary expansion through QE, which has had the helpful consequence for the Treasury and Debt Management Office that the Bank has become a major buyer of gilts and financed a substantial chunk of the deficit. This is indeed one of the main reasons for the low gilt yields, not just market confidence in the UK as a safe haven or market gloominess about growth prospects.

    My concern isn’t that this unconventional monetary financing of the deficit is inflationary; it certainly could become so, but for now it isn’t as it merely offsets the contraction in bank lending and credit. (Inflation is a problem via a different channel, with high commodity prices squeezing real incomes and thus consumer spending, but I’m not sure the Bank can do much about this without tanking the domestic economy, given the still-high level of consumer indebtedness.)

    The problem is that we are already relying heavily on QE to finance the deficit, and a switch in the form of QE (buying commercial paper, which Mervyn King seems to have set his face against but others here have advocated) and its eventual withdrawal will lead to a huge challenge for the DMO to shift the required quantity of gilts at reasonably low yields and therefore servicing costs.

    3. Most of the forecast borrowing in this Parliament is not due to automatic stabilisers. It’s the structural component of the deficit, which is why it requires a policy response. I agree that the automatic stabilisers should be allowed to work, but unfortunately they account for only about 20% of our current deficit according to the OBR.

    4. I have no objection to taking advantage of the low gilt yields to fund public investment projects that should boost the economy’s productive potential. To a large extent this can be done even within the tight capital budgets currently forecast, and given the low financing costs public works should be financed this way and not via complex PFI-style wheezes. I would rebalance the current/capital mix within current totals, say by transferring about £10 billion from departments’ current to capital budgets. This would mean there would be small real-terms cuts in both rather than (as at present) large cuts to capital and almost no reduction in current spending. Given the higher multipliers for capital spending, this could be seen as a revenue-neutral stimulus but (like any other stimulus that would be remotely affordable) I agree it could only make a small difference, primarily to the construction industry.

  • Bill le Breton 26th Apr '12 - 9:22am

    You night owls – how can an ol’ feller keep up?

    Joe, may I take point two first – the famous Milton quote, which might also have been written, “Deflation is always and everywhere a monetary phenomenon”, which is why the stimulus must be monetary. In 1976 the problem was too much money (being created by unsterilized Gov Ex) today it is too little being created by the private sector.

    For the Big Plan to be a big enough game changer there must be some sterilization through gilts, but the problem remains that more money is being destroyed than created. What is needed at this stage is Domestic Credit Expansion with a purpose to increase the wealth of the nations of the UK.

    The private sector is not ready at this time psychologically to do what is necessary to create money – that must reside with the Government and the advantage of that is that in so doing there is a straightforward link to demand.

    QE has kept the stock market afloat but that has not (yet) encouraged firms to use the market to raise investment finance. That will only come when the psychological position has been transformed.

    This requires a communications campaign expressing a new direction by true leaders (and not political managers). Their management of expectations has been entirely negative and they are reaping what they have sown – fear, retrenchment, waste of human potential.

    So there has to be a National Plan for Recovery based on Government leadership in the first phase. Details would include reductions in taxes that discourage employment. Job guarantees linked to the removal of everything that discourages people contributing positively to their communities in return for wages.

    There is so much to do in our communities that will make them stronger, more sustainable and more pleasing to be a part of and contribute towards.

    But above the detail our leaders have to communicate the big picture of transformation and of our nations ‘tooling’ up for this part of our history. The great Common Purpose.

    There is an alternative economic policy (see my comment above), there needs also to be an alternative social policy, based on building a culture of hope, co-operation, ease and (old fashioned word) joy.

    Hope is inspirational, motivational and unifying.

  • John Carlisle 26th Apr '12 - 9:32am

    Why is there so little mention of banks? I know it sounds obvious, but banks HAVE MONEY. Barclays Capital made over £3 billion this quarter; HSBC made £14 billion in 2011/12; RBS has put £400 million aside as a bonus pool. There simply must be billions available for UK lending to business, especially cash flow demands in construction. Every time a business goes bust because of lack of bridging capital its bank should be called to account.
    Final question – just where does the profit go to? Is there such a thing as too much profit (and I include Apple and Google here)? The entities who created that wealth are the suppliers and employees. If it is they who are being squeezed then the bank or OEM is being utterly unethical and should answer to BIS.
    Time to go back to Marshall and the velocity of circulation theory as opposed to QE. Come and Vince and Nick do the obvious: get the money circulating.,

  • Alex/Bill,

    good analysis guys and very interesting discussion. I am sure (hope) our parliamentary group must be having similar discussions.

    If we don’t see a sustained pick-up in growth by the third quarter, I am starting to think we should push fora definitive commitment to raising of the personal allowance to 10k in this years autumn statement.

  • Simon Titley 26th Apr '12 - 12:05pm

    I suggest that the remaining diehard fans of the government’s austerity policy take a good look at this:
    http://www.businessinsider.com/chart-of-the-day-us-vs-uk-growth-2012-4

  • Bill le Breton 26th Apr '12 - 12:39pm

    John, a guy called Rogers (I think) said something very wise back in the 1930s about those times which are similar to those of today. “I am more concerned about the return OF my money than about the return ON my money.”

    When that is the mind set, then, you will put your money away in the safest risk-free place possible. At the extreme, in deflationary times, that is literally under the bed. It will buy more tomorrow than today and there’s no chance of the asset you buying falling in price.

    For Banks they have the risk free option of putting it on deposit at the Bank of England and making a small but safe return. Of course if the Bank of England charged them for holding their money there, they might have to think of something else to do with it.

    This is what is influencing those big banks. It is what is influencing those firms sitting on their cash piles.

    That is why the momentum has to start with us pooling the risk of the initial investment projects collectively through Government investment, but as part of a total rethink of the way Britain works (or to borrow from Saatchi, isn’t working.

    Nor should we forget that those who advocate a massive reduction in the size of the state have a vested interest in making use of the spurious notion of the state as a % of GDP which obviously rises during a recessionary times (as stabilizers kick in and as GDP falls).

  • John Carlisle 26th Apr '12 - 2:18pm

    Bill
    Rogers was obviously not a banker. The banker only makes money by getting a return ON it – or should. Their role is to lend money. I have assets, they have money. I deploy my assets to get an income, i.e. I sell something that someone values. Banks use my money to invest or lend. Simple. But they have lost the plot, so someone else should do it. Or should they?
    What you are saying is that it is OK for banks to make money for their shareholders by arbitrage, warrants etc., but not for their customers, when money is their ONLY asset, and the only thing I want from them as a businessman.
    In which case, nationalise them, now.

  • Bill,

    Lord Oakshott called yesterday for the Coalition to borrow more using the UK’s record low interest rates to fund an ambitious national home-building programme.

    Came across this article supporting your QE idea Money and mind-set

  • Bill le Breton 26th Apr '12 - 2:49pm

    John, forgive me for being imprecise. I was explaining not justifying the behaviour of banks. I think you speak of more normal times.

    My recommendation would be to charge banks for holding excess reserves at the B of E and not as at present to pay them for it. Will Rogers was in fact a cowboy, but the quote may have originated from Mark Twain, but may also have been used by Keynes.

    The point is that this is the psychology behind the caution being shown across the private sector over putting money at risk. If there is this considerable level of consequential ‘saving’ in the private economy, Gov borrowing by identity will be equal to it. Any reduction in G will result in a fall in GDP.

    As GDP falls so the ratio of G:GDP will rise giving ammunition to those who are arguing for a ‘drastic’ reduction in the size of the state. Newsnight last night warned us to expect a very high level Tory coming out strongly in favour of this in the next day or two.

    Paul Mason has been warming up this argument (the point man???) for a number of months.

    We shall have to watch carefully to see the reaction to this of Clegg and Alexander.

  • Terrye Teverson 26th Apr '12 - 5:00pm

    As a manufacturer and talking to all sectors across the UK it was clear that there had been a dramatic downturn in the first quarter of this year. I have heard various comments like, I have been in business for 25 years and this was my worse February ever. The whole problem is lack of consumer confidence. All the new shop stock is already heavily discounted and summer hasn’t even started yet! As one of my staff said to me,”It’s not whether to buy it or not it’s do I need it at all”. People are making do and mending not spending.
    Anyone watching the news last night must have though can it really get any worse – double dip recession, Murdoch, sleaze, wealthy mingling with each other for mutual benefit, and flood warnings while in a drought zone!!!

  • Alex Sabine 26th Apr '12 - 5:03pm

    Simon,

    The problem with these glib assertions about the superiority of the US over the UK approach is that they are based on a false premise: that the US has been stimulating aggressively while we have been cutting like crazy.

    Once again, it’s worth looking at the actual figures rather than just the political rhetoric. From the White House Office of Management and Budget, here are the official figures for federal spending, expressed in real terms (constant 2005 dollars):

    2009: £3.173 trillion
    2010: £3.081 trillion
    2011: £3.126 trillion

    So, US federal government spending has in fact been cut in real terms since 2009. As a percentage of GDP, federal spending has fallen from 25.2% in 2009 to 24.1% in 2011.

    Around a third of all public spending in the US is done by state and local governments, so really we need to look at figures that factor this in.

    Here are the figures for total government spending (federal, state and local combined), expressed in constant prices:

    2009: £4.664 trillion
    2010: £4.526 trillion
    2011: £4.594 trillion

    So total government spending has also been cut in real terms over the past three years and it has fallen from 37.1% of GDP in 2009 to 35.4% of GDP in 2011.

    Now let’s look at the figures for Total Managed Expenditure in the UK, expressed in real terms (converted from the cash figures using the GDP deflator, which is the measure of economy-wide inflation used by the OBR in the fiscal tables):

    2009-10: £669.7 billion
    2010-11: £669.5 billion
    2011-12: £663.5 billion

    As a percentage of GDP, spending has fallen from 47.6% in 2009-10 to 45.8% in 2011-12.

    So it’s a very similar pattern, with the cuts if anything slightly milder (and beginning later) in the UK. The cumulative fall in real-terms public expenditure from 2009 to 2011 is 1.5% in the US and 0.9% in the UK.

    So far as the impact of spending cuts in the UK is concerned, it’s hard to believe that a reduction in government spending averaging a little more than £3 billion per year over the past two years can have had more than a negligible effect on the total output of a £1.5 trillion economy.

  • John Carlisle 26th Apr '12 - 5:19pm

    OK, OK, OK! So we do have a strategy (or the makings of one from all this intellectual capital). It is just not in the leaders’ heads. How do we do that and craft sensible LibDem policies ?
    Thank you for the best discussion ever on this blog.
    Bill, thank you for your forbearance of my humourless reply; but bankers were not always like this. A year ago I met the daughter of the small banker near LA who gave his personal guarantee for a £500 loan in 1939 to two engineers, Hewlett and Packard, because he knew they were damned good engineers and he trusted their characters. Today the bankers themselves “design products” instead of lending to those who really can create wealth.

  • Simon Titley 26th Apr '12 - 5:56pm

    @Alex – But there remains no evidence that voodoo economics works. Contractionary fiscal policy is contractionary:
    http://krugman.blogs.nytimes.com/2012/04/26/the-new-voodoo/

  • Alex Sabine 26th Apr '12 - 5:57pm

    In reality the US government’s overall spending stance has been pretty similar to the UK’s. It’s true there was a larger stimulus in 2008-09, but bear in mind that the US has much weaker ‘automatic stabilisers’ due to the smaller welfare safety net, while cash-strapped state and local governments often have to cut spending during recessions due to requirements to balance their budgets. So in the US a discretionary stimulus is required simply to mimic the effect of the automatic stabilisers that operate in Europe.

    Where there has been a noticeable difference between the US and the UK has been on the tax side, although more by accident than design as the US government’s coffers took a bigger hit from the financial crisis than ours did.

    US total government receipts fell by a whopping 12.4% in cash terms in the 2009 fiscal year, partly due to deliberate ‘stimulus’ tax cuts but mainly because of the impact of the recession on revenues.

    Total government revenues in the US fell from their 2007 peak of 28.9% of GDP to 25.1% of GDP in 2009, the lowest share since 1965, while federal revenues slumped from 18.5% to 15.1% of GDP, the lowest share since 1950. They have now inched back up to 25.5% and 15.4% respectively. Strikingly, both federal and total revenues are still below the 2007 pre-crisis peak in cash as well as real terms.

    By contrast, UK government receipts fell by a more modest 3.7% in 2009-10. By 2010-11 they were already higher in cash terms than before the crisis, and they are now 11% higher (£570 billion in 2011-12 vs £514 billion in 2009-10).

    Tax as a proportion of GDP fell from the pre-crisis peak of 38.6% (in 2007-08) to a low point of 36.6% in 2009-10, a much smaller drop than in the US. It is now back up to 37.5%, a fairly typical ratio for the UK in recent decades and close to the limit of what previous governments have been able to sustain.

    To get an idea of the overall fiscal stance in the US and UK, we can look at the size of the deficit and the rate of change in the deficit. Here are the figures for the federal deficit and total government deficit as a % of GDP in the US:

    2007: 1.2% / 2.1%
    2008: 3.2% / 4.8%
    2009: 10.1% / 12%
    2010: 9% / 10.2%
    2011: 8.7% / 9.9%

    In the UK the figures are:

    2007-08: 2.5%
    2008-09: 6.7%
    2009-10: 11.1%
    2010-11: 9.3%
    2011-12: 8.3%

    So, as you can see, there has been a broadly similar pattern. The deficit at the end of the boom years (2007) was higher in the UK, but it ballooned in a similar fashion once the crisis took hold.

    In the US, plummeting tax revenues played a bigger part, and the fact that these have not yet been replenished means that the US government has had a slightly more expansionary fiscal stance overall over the past two years. The federal government has also been sustaining some (but not all) of the demand withdrawn by cutbacks at the state and local level.

    The UK government (under both Labour and coalition policies) started raising taxes sooner, with rises in NI, VAT, capital gains tax and cuts in tax relief only partially offset by increases in the income tax personal allowance.

    So the difference in fiscal stance is quite small. And to the extent that the US government has adopted a more expansionary stance than the UK government, it has been due to lower taxes rather than higher spending.

  • Alex Sabine 26th Apr '12 - 7:08pm

    Simon: You linked to an article which purports to show that the US is recovering faster than the UK and eurozone because of a radically different fiscal policy. I sought to ground the discussion in the facts of what is actually happening to fiscal policy. These show that the US/UK policy dichotomy is greatly overstated and, insofar as it relates to public spending, non-existent.

    (We can debate whether the Labour and coalition governments have been right to raise taxes while the US government hasn’t, but that isn’t the main objection I hear from opponents of the fiscal strategy in the Lib Dems. It’s all about ‘cuts’.)

    The article you link to also wrongly claims that the British government is in the business of trying to reduce the national debt, which is clearly absurd given that the debt is projected to rise from £905 billion in 2010-11 to £1.37 trillion by the end of this Parliament.

    Of course, under any plausible policy scenario, the debt was bound to continue on its upward trajectory for several years. This is unavoidable unless you can somehow eliminate the deficit overnight, which isn’t possible. (This is a point that sometimes eludes the Tea Party types in the US.)

    The government’s aim is a more modest one: to get the deficit to a point where we can at least stabilise the debt:GDP ratio by 2015 and then set it on a gradual downward path. Call that voodoo economics if you like. But the idea that the British government is allergic to debt is unhinged from reality.

    By all means suggest alternatives to current policy, but let’s base it on the facts and not a caricature.

    Re the Krugman graph, I think the most significant point is that being part of a single currency of which the export-based German economy is the linchpin is undoubtedly having a contractionary effect on weaker economies that can’t regain some form of competitive equilibrium and offset fiscal austerity through currency depreciation and monetary stimulus. They also have far less leeway with the bond markets than we do, which is why we continue to be able to run much higher deficits than almost all eurozone countries and are making a less front-loaded fiscal adjustment.

  • John Carlisle.

    “How do we do that and craft sensible LibDem policies ?”

    Vince Cable has taken a good stab at a LibDem Industrial Policy in his Letter to David Cameron and Nick Clegg.

    He says the priority now is implementation of plans for growth and development of a compelling vision beyond sorting out the fiscal mess. He goes on to say that market forces are insufficient for creating the long term industrial capacities we need and we must lay out a strategic vision for delivery.

    He makes five key recommendations of what should be done:

    1. Identifying and supporting key technologies to drive future economic activity.
    2, A strategic and proactive approach to supporting British success stories.
    3. A focus on development of domestic suppliers to meet public procurement needs .
    4. A National Investment Bank and initiatives to develop alternative non-bank channels as sources of funding to viable business.
    5. Galvanising the housing and infrastructure construction market.

  • Austerity sounds attractive because it look cheap. But it doesn’t actually work. Its text book stuff. Not only that, this Party did not stand on the policy in opposition because it knew it was wrong. The only reason anyone in the Party is defending it now is because the coalition is reliant on it. The electorate has become less important than party politics.. It’s a ludicrous situation.

  • Listening to the likes of Terrye Teverson is a reminder of the real world and Clegg should take a lesson from him.

    As Glenn rightly says the political problem for the party is having rubbished the very economic policies it is now forced to support (and which clearly are not working – remember the growth forecasts being made eighteen months ago?) it’s now in a complete paralysis as to what to do next.

  • Jayne Mansfield 27th Apr '12 - 10:42am

    In defence of Nick Clegg. What else could he say?He and the Lib Dems are now hostage to Tory fortunes.

    Working to improve the economy appeared to be the raison d’etre of being in coalition with this government and support for tory policies.

    This sacrifice seems not to be appreciated by the likes of Liam Fox and his friends who are ensuring that the problems with the economy are being blamed by the Lib Dems in government.

    Although not an economist, I can see that austerity is not working and I don’t see how more austerity will alter that fact. We are taking the nasty medicine and it is showing no benefits.

  • Richard Dean 27th Apr '12 - 10:55am

    The impression people try to give me is that he LibDems went in to coalition mainly to reform the voting system. The electorate roundly rejected the reforms in a referendum, and now the LibDems don’t have a raison d’être, or indeed any particulary distinct identity!

    I agree that austerity is a crazy policy if it leads to high levels of employment like the 25% average, 50% youth that they have in some parts ofthe EU. I suppose that, for some people (not me), unemployment serves some economic or other purpose, and I’m wondering what it could be. Keep the workers in check? Keep wages down? Reduce imports (because giving people jobs and wages also gives them cash to buy imports with)? What can it be?

  • Terrye Teverson is right when he says “The whole problem is lack of consumer confidence.”

    Once confidence is restored the economic and fiscal problems become largely self-correcting.

    Beyond efficiency measures, the absolute worst thing that can be done right now is resurgent attempts aimed at reducing the size of the state that only serve to dampen confidence further. Reduction in the relative size of the state comes about naturally as the private sector expands its activity and does not need to be forced during a recession.

    The easiest and quickest way to kick-start activity and get money wages into the real economy is through the constructiion sector. Getting finance into the hands of housing associations and local authorities to galvanise the housing market seems the obvious place to start and seems unlikely, of itself, to put upward pressure on public sector borrowing costs at this time.

  • Jayne Mansfield 27th Apr '12 - 12:51pm

    As a consumer, I have no confidence in George Osborne and Danny Alexander whose set stock in trade response is that it is all Labour’s fault.

    I would have more confidence if there was an economist at the helm, step forward Vince Cable.

  • Alex Sabine 27th Apr '12 - 1:42pm

    Regardless of how people commenting here think the government ought to proceed, the assertion by Glenn and others that the Lib Dems stood against austerity in opposition is simply untrue.

    There was a surreal debate in the run-up to the election about £6 billion of in-year cuts (relative to Labour plans, not actual cuts in overall spending) in 2010, and on this issue it’s quite fair to point out that the Lib Dems lined up with Labour and changed tack after the election. Most economic commentators and people in the markets viewed the obsession with this narrow issue during the campaign as largely a matter of posturing by all three parties, which helpfully diverted attention from the fact that no party had set out anything like the measures they would take over a whole Parliament to fill the huge gap in the public finances which they all recognised existed.

    However, on the more general issue of tackling the structural deficit, Nick Clegg, Vince Cable and others not only acknowledged the need for austerity but sought to portray themselves as more honest and hard-headed on the issue than both the other two parties.

    For those who doubt this, consider the following statements.

    From Nick Clegg writing in the FT in January 2010: “In recent weeks, the markets have been jittery about the upcoming general election and the uncertain impact of its outcome on government spending. They are right to worry: the consequences of failure to bring the deficit under control could be very damaging for Britain. There is, in theory at least, the possibility that a sudden collapse in confidence will undermine our ability to borrow at reasonable rates.

    “This cannot be allowed to happen: a credible plan must be set out to deal with the deficit, and it must be delivered by whatever government is formed after this year’s election.

    “It is very clear that, as in the US, current levels of borrowing cannot continue without putting Britain’s credit standing at risk. We should not forget that at present, government borrowing is being artificially sustained through quantitative easing whereby, in effect, it buys its own debt.

    “That is why I regard bringing stability back to public finances as the first big building block of our plan to rebalance the economy and build it up again on firmer foundations than before.

    “To maintain confidence, it is vital that steps are taken now, before the election, to demonstrate clear commitment.”

    Clegg also argued that the Lib Dems favoured an entirely spending-based consolidation except for a bank profits levy, and implied that Labour and the Tories would be tempted to go for the ‘soft option’ of tax rises.

    He wrote: “The sense is growing that the next government may lack the courage for cutbacks and resort, instead, to painful tax rises. That is not the approach of the Liberal Democrats now, nor will it be in government.

    “We have proposed one new tax on the profits of banks, until they can be split up, to ensure they pay for their ongoing implicit taxpayer guarantee. Beyond this, I believe deficit reduction should be focused on spending cuts.”

    http://www.ft.com/cms/s/0/cf8268e0-0141-11df-8c54-00144feabdc0.html#axzz1tEtX2bcv

  • Alex Sabine 27th Apr '12 - 1:46pm

    Vince Cable was saying much the same thing the previous autumn – indeed he wrote a whole paper on “Tackling the Fiscal Crisis” in an attempt to steal a march on the other two parties and lead the debate.

    http://www.reform.co.uk/client_files/www.reform.co.uk/files/Tackling%20the%20fiscal%20crisis%20FINAL.pdf

    The guy many people here seem to want to claim as a tribune for the anti-austerity cause was in no doubt about the looming fiscal crisis. He wrote:

    “The central issue emerging now in the UK – and the one which will dominate politics for the next few years – is the size of the UK government budget borrowing and deficits, and government debt. The stark reality is that much of the deficit does not represent either automatic stabilisers or a deliberate fiscal stimulus; it is “structural” in character and will not be reversed on recovery.”

    Moreover, he argued that the Labour government’s plans for deficit reduction were inadequate because they did not deal with the whole structural deficit, and he judged that a larger fiscal correction would be required to put the finances in order. Indeed, his recommendation of a fiscal policy adjustment of around 8% of GDP foreshadowed almost exactly the coalition plan.

    Cable wrote: “A reasonable assumption is that a correction of around 8 per cent of GDP is required (the 10 per cent borrowing requirement excluding the cycle or deducting 2 per cent for public investment).

    “The conclusion is this: first, a substantial fiscal adjustment is required, more than existing Government proposals; second, the government is right to argue that any consolidation should be measured rather than sudden, since the latter could abort recovery; but, third, Britain is exposed to the risk of declining market confidence and market concerns over inflation leading to an increase in borrowing costs; and, therefore, fourth, it is necessary for any government to have a plausible plan to eliminate the structural element in the fiscal deficit.”

    Later he pointed out that the Darling plan made heroic future assumptions about growth rates based on a rapid return to normal economic conditions: “The Government estimate of the structural deficit is at the lower end of the range of possibilities and a brisk economic growth rate is assumed after 2011-12. Many, including the author, would argue that such growth – over 3 per cent per annum – is highly optimistic given the likely impediments to strong recovery: namely the reluctance of consumers to borrow to spend in the wake of overextended household balance sheets, the continued difficulties for companies in raising capital to expand, the Government’s own fiscal retrenchment and weakness in major export markets. A period of slow growth, continuing large structural deficits and rising government debt is very plausible.”

    His conclusion?

    “The clear implication is that the fiscal adjustment – through taxation and/or public spending, particularly current spending – has been underestimated and will have to be bigger than this Government has budgeted for.”

    Like Clegg, Cable was also adamant (perhaps surprisingly so) that the deficit reduction should rely predominantly on spending cuts and not tax rises. He argued:

    “The emphasis for fiscal consolidation must fall on controlling public spending, not higher taxes: to commit to additional tax revenue raising from the outset undermines any commitment to setting priorities in spending.

    “This process will be painful and difficult. It will involve real cuts in many areas and will mean that the big budgets – health, welfare, defence and education – must be tackled. There should be no “ring fenced” areas of spending. Existing spending has to be justified, not simply assumed to be necessary and trimmed at the edges.”

    He noted: “Government spending as a share of GDP has risen to 48 per cent, partly reflecting the increased demands on public spending in a period of recession. But there has been an extraordinary growth in the share of public spending over a decade – by over 10 per cent of GDP. This is quite an increase, especially in a briskly growing economy.

    “In the UK public spending has been allowed to grow very rapidly on the back of what was a windfall in tax revenue. Tax revenue depended to an unhealthy degree on a “bubble” economy in financial and housing markets. Much of that revenue has now been lost and, though it may return in part and at some stage, it would be foolish to base future spending commitments upon it.

    “A related point is that the rapid increase in spending has often been inefficiently spent without adequate democratic accountability and with declining productivity, to the extent that we can meaningfully define and measure it in public services. The Office for National Statistics estimates that public sector productivity declined by 3.4 per cent from 1997 to 2007 while private sector productivity rose by 27.9 per cent. The sudden deluge of funding (in relation to comparable OECD countries) has been likened by Reform to a “flash flood” and there is a strong argument for focusing on how resources can be better spent rather than validating current spending levels with higher taxes.

    “In addition, direct taxes create disincentives to save, work and take risks while indirect taxes are generally regressive. Moreover, the overall tax system is widely perceived to be unfair with low income groups paying disproportionately and the very wealthy treating tax as a, largely voluntary nuisance.

    “So the emphasis should be on spending control; though the magnitude of the fiscal adjustment required is such that taxation cannot be ruled out… To commit to additional tax revenue raising from the outset undermines any commitment to setting priorities in spending.”

    Even while broadly supporting the Labour government’s position on the question of when to begin deficit reduction (which is not the same thing as how fast it should proceed or how deep it needed to be, on which he judged Labour’s plans insufficient), Cable rightly acknowledged it was a question of balancing risks at the time and not a black-and-white decision; writing in September 2009, he judged that we were “approaching the point” where it should begin. He also reckoned that continuing monetary policy stimulus would play a much more important role in sustaining demand than fiscal policy.

    Sorry to rake over all of this again, but I felt it would be worthwhile since a number of people here seem intent on rewriting history by claiming the Lib Dems “opposed” austerity until they joined the coalition and then performed a 180 degree turn in order to get their place at the Cabinet table.

  • Alex,

    a very good summary of how we got here and the reasons why.

    As you rightly point out, it is not government austerity that has choked off growth in the UK – much of the spending restraint is yet to come. We have not recovered from the effects of the financial crisis. Persistent inflation and unavoidable tax rises have reduced disposable income at the same time as many are attempting to reduce debts. Europe’s travails have subsumed the positive effects of a sterling devaluation on manufacturing exports. Business Investment has been falling while consumer demand remains slack.

    Last November Vince Cable said, “the common view was the recession would not last too long but I think we can now see signs that it might be really quite protracted. When I talk about recession, I’m talking about it not in the economic sense – two consecutive quarters of negative growth – but as most people see it, with job losses, house repossessions and a lack of consumer spending. The doomsday scenario would be that we finish up like Japan did, with ten years of stagnation.’

    I think this is the crux of the matter, or as Keynes said “When the facts change, I change my mind. What do you do?”

    A realistic assessment needs to be made of the consequences of continued failure to meet the growth targets in the OBR forecast versus the potential impact on borrowing costs of public investment substantial enough to push GDP growth back to trend. There are costs and benefits to any economic policy. We have only three years of this Parliament remaining in which to make a difference – so we need to get it right.

    My own view is we should make a clear distinction between current spending and investment i.e. we should not try to shore up aggregate demand with increased current public spending – that should be left to find its own sustainable level. We should however, maintain overall investment output with public sector spending, until such time as the corporate sector is confident enough to once again begin increasing its capex.

  • Alex Sabine 27th Apr '12 - 3:25pm

    I largely agree with your last post Joe. I don’t think it’s time to push the panic button yet and rip up the deficit reduction plan, but I do think there is scope to shift some resources into public investment within the planned spending envelope – particularly given the starting point which is that the government is relying disproportionately on capital spending cuts compared to current spending cuts, even allowing for the fact that it’s easier to cut.

    You are certainly right that all policy options have their costs and benefits. It’s also the depressing reality that, as a consequence of past mistakes, we have little room for manoeuvre. There are certainly no quick fixes.

    I agree with the thrust of this article by Jeremy Warner: http://www.telegraph.co.uk/news/politics/georgeosborne/9226293/George-Osborne-can-stop-the-rot-but-only-by-spending-as-he-slashes.html

    As he says: “…Dire though the situation is, it’s important to keep a sense of perspective. To think that the mess the UK economy finds itself in is the result of government actions over the past two years is to descend into fantasy. Lack of growth is almost entirely down to the after-effects of the financial crisis, and we all know who was responsible for that. The travails of the eurozone have further obstructed the path to recovery.

    “…Even if the GDP had grown a little, depriving Mr Balls of this moment of triumph, it wouldn’t have changed the big picture, which is of an economy deeply impaired by a continuing banking crisis.

    “If the Chancellor made a mistake, it was in believing that the mere act of deficit reduction would rekindle growth. This was never very likely with everyone else – households, banks and major export markets in the eurozone and beyond – all deleveraging at one and the same time. But this doesn’t mean that the strategy is wrong.

    “An overblown banking sector makes Britain particularly vulnerable to the sort of sovereign debt and financial market contagion we have seen sweep the eurozone. To engage in further fiscal stimulus at a time when the Government is already adding to the national debt at the rate of about 10 per cent of GDP a year would be to take extreme risks with interest rates. Any significant rise in the cost of money for a country as indebted as Britain would be catastrophic.

    “The differences between Labour and the Coalition on macro-economic policy are in any case more about rhetoric than substance. Continued economic contraction has caused the automatic stabilisers to kick in, slowing the pace of deficit reduction to one that is actually not so very different to that planned by Labour before it lost power.

    “In a way, the Government is already doing what Labour demands, to the dismay of those who thought a Tory-led administration would match words with actions in pursuit of a smaller state. The automatic stabilisers of welfare spending would in many other countries, including the US, be counted as a discretionary fiscal stimulus.

    “It has long seemed to me that the Government has got the broad outline of the consolidation about right – just enough to keep the markets sweet, but not so big that it causes a vicious cycle of decline in the economy.

    “Yet whether it is right about the composition of deficit reduction is much more questionable.

    “Part of the challenge for advanced economies is that companies have lost the confidence to invest, and are therefore hoarding profits rather than spending them. In the UK alone, the corporate cash mountain has doubled over the past decade to £754 billion (a sum equivalent to half of GDP), with much of that growth occurring since the crisis began.

    “When companies won’t borrow to invest, there’s a strong case for governments to do so in their place. And yet when you look at where the axe is falling hardest, it is on government investment – spending on schools, hospitals, roads, bridges, affordable housing, and so on. This is the easiest thing to chop, so that’s where the Coalition has acted first.

    “In fact, this form of state spending should be doubled, tripled or even quadrupled, with the money made up by further cuts in entitlements and bureaucracy. Such a combination of increased investment and decreased current spending promises a virtuous circle of growth and job creation – without in any way undermining deficit reduction.

    “For the moment, the Government lacks the courage and imagination for such strategies. If there are any positives to be had from the economic tsunami sweeping in from the eurozone, it might at least help galvanise the necessary change in approach.”

  • I meant the austerity package in the form it is in. Like Labour the Lib Dems were warning about of the dangers of cutting too far too deep. I remember this distinctly. Either way it’s irrelevant because it isn’t working and will never work. You can even find articles in the New York Times arguing that Britain’s stagnant economy is self inflicted and driven by ideology rather than good fiscal policy. And if the damage and lack of confidence already inflicted by Osborne’s plans have barely even started what do you think is going to happen next.? All of this talk of long term plans is reliant on being re-elected which looks less and less likely.

  • Glenn,

    even with a significant public infrastructure investment program, there may be no way out of a painful restructuring over the next several years as Dr. Tim Morgan writes in this report from last year Thinking the unthinkable

    He concludes “the economic outlook for the UK is grim, and individuals can longer be insulated from this by government borrowing. One requirement that has been established here is to free up SMEs to invest and create jobs, a requirement which means reversing much of the complication and bureaucratic meddling which was forced upon businesses by Labour’s moral absolutism. But a second requirement is to build a social cohesiveness which can start
    to overcome the division of society into warring interest groups, and a third is an imperative need to offer the public some offset to the depressing economic conditions that are now beginning to unfold.

    We believe that each of these objectives can be furthered by the creation of a radical ‘liberty agenda’, getting government off the backs of the public and administrators off the backs of front-line public sector workers.
    Where the general public is concerned, one of the most distressing features of Britain’s evolution over the last
    two decades has to have been the relentless spread of surveillance and coercion. Britain is plastered with
    warning notices, CCTV and speed cameras, and other aspects of the surveillance state. Government needs
    to start stripping away much of this panoply of surveillance and coercion, and to enshrine in law the primacy
    of individual liberties. The Coalition cannot leave the electorate better off in 2015 than they were in 2010, but
    it can certainly leave them freer from the meddling of the state. Over the past twenty years, the “nanny state”
    has mutated into the “bully state”, a process which has been in part a logical extension of the national disease of bureaucracy and in part a result of the doctrines of moral absolutism and entitlement.

    The public also needs to be freed from exploitative practices in the private sector, most notably in the form of “terms and conditions” (known to a previous generation as “the small print”), and also in the form of exploitation of the public’s lack of understanding of banking and other financial matters. In addition to strengthening existing consumer
    protection systems, government should create a Consumer Court, empowered to set aside onerous, unreasonable and one-sided contractual terms.

    The scale of Britain’s underlying economic weaknesses is such that David Cameron and Nick Clegg cannot realistically expect to make Britain a richer country, but they can most certainly make it a freer one. ”

    If Dr. Morgan’s prognosis is right (and it is hard to argue with the basic facts), we may be able to lay the foundations for a better economic future over the next three years, but we will not see the fruits of those efforts by the time of the next election and should look to delivery of a ‘Liberty Agenda’ as the demonstable achievement of this coalition government.

  • Richard Dean 27th Apr '12 - 6:20pm

    Why would change take so long?

  • Joe.,
    thanks for the reply.

  • Richard,

    the pre-crash economic growth was based on foreign sourced private and public credit – financial services, housing, construction, retail, health and education, expansion of tax credits and benefits. That is not coming back – nor would we want it to.

    GDP growth now has to come from earnings – profits and wages- not increases in borrowings. That means a major rebalancing of the economy to sectors that are capable of generating growth without reliance on increasing levels of debt.

    Nick Clegg says in his speech “These are not overnight projects.” “there are no short cuts.”

    The OBR growth forecasts for future years are looking increasingly optimistic. Without robust growth, the deficit reduction plan falls apart, interest costs will rise and both deeper spending cuts and higher taxes will be needed to make up the shortfall, even as they compound the economic problem.

    Accelarating infrastructure investment projects now may help to stimulate some growth and get some demand into the economy, but the underlying structural problems and economic rebalancing remain to be worked out over an extended period of time.

  • Richard Dean 27th Apr '12 - 9:04pm

    Joe,

    Thanks, You economics experts seem to have such nice santized ways of telling us poor people we’re gonna get screwed. By “re-balancing” I guess you mean that large sectors of the workforce will lose their jobs and have to find new ones in new industries? While the culprits in the City drive their expensive cars from one expesnive house to another?

    Do we still believe the OBR after they got the growth forecast wrong? I seem to remember checking their arithmetic not long ago and finding it didn’t add up! If this re-balancing goes ahead, where is the consumer confidence going to come from that people say is needed to get the growth?

  • I love Clegg’s ludicrous comment about “pulling the country back from the brink”

    In May 2010, when the Coalition took over, the economy was growing strongly (1.1% in 2010 Q2) with interest rates low. If the economy had kept recovering at the rate it was under Labour, we would – like Germany and the US – now be back past the 2008 peak.

    The truth is that the Coalition have screwed it up. Their cuts haven’t just sucked demand out of the economy, but they’ve sucked confidence out of the economy and now we see the result.

    At least the Tories want these cuts for ideological reasons. The Lib Dems made the catastrophic decision to reverse their pre-election position and it has now delivered disaster…

  • Peebee and Joe Bourke – Terrye Teverson, “she”, not “he”.

  • Listening to Cameron this morning on Andrew marr, re “rebalancing of the economy” etc, I find it difficult to believe the Government is genuinely trying to do it! Re your remark Richard Dean about the ‘culprits in the City’ getting off scot free, I thought they were supposed to be the ones being rebalanced out of the equation. But looking at the Government’s actions rather than its words, I find that my assumption is most unlikely!

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