“We used to think you could spend your way out of recession and increase employment by boosting government spending,” boomed Prime Minister Jim Callaghan, at the 1976 Labour party conference. “I tell you, in all candour,” he went on, “that that option no longer exists. And in so far as it ever did exist, it only worked on each occasion … by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step …”
The above words are among the most important uttered in the history of modern British politics. For a left-wing Prime Minister to have admitted that too much state spending is dangerous, while barracked by a rabble of bearded Trotskyists from among his own party ranks, marked a turning-point in Western economic policy-making.
For it was in 1976 that the UK government had been rescued by the International Monetary Fund. After years of industrial subsidies, soft-budget constraints and Keynesian hubris, Britain was insolvent – unable to service its debts. After months of denial, the markets forced Callaghan’s government, “cap-in-hand”, to seek an IMF bail-out. On that day, all notions that the UK remained a world-class economy, an industrial powerhouse, were exposed as nonsense. It was this country’s “economic Suez”.
What brought Britain to that disgraceful nadir was a lot of self-serving ideas about the wisdom of near-limitless government largesse. The “Keynesian consensus” had been that the state could borrow and spend practically ad infinitum, that “pump-priming” the economy was “the right thing to do”.
By stating the obvious, “Sunny Jim” smashed-up that consensus. His criticism of “big government”, amounted to political blasphemy. Callaghan’s words, though, were the high-water mark of Keynesian economics – which afterwards rapidly retreated. We had tried high state spending and it didn’t work. All it did was produce ghastly inefficiencies, inflation and, worst of all, expose supposedly sovereign governments to their wrath of their private sector creditors.
In February 2010, in a public letter, 20 prominent economists backed George Osborne’s plan to cut the UK’s annual fiscal shortfall over 5 years. Published in the run-up to the general election, this boost to the Conservative’s deficit reduction plan was seen as political significant. Last week, we were told that 9 of those same 20 economists said the Chancellor now should abandon his plan, or at least water it down by agreeing to more “fiscal stimulus”.
The UK economy is yet to recover from the “sub-prime” crisis. Real GDP remains 4pc smaller than during the first quarter of 2008. With the economy expected to contract 0.5pc this year, Britain is in a double-dip recession. That’s why, with the euphoria of London 2012 fast fading, the political classes having abandoned their “Olympic truce”, Osborne is now under intense pressure to throw budgetary caution to the wind, even from some within his own party. The volte face of these various economists is the latest chapter in the UK’s “growth versus austerity” debate – a debate being closely watched elsewhere.
“Growth versus austerity”, though, is a false and dangerous dichotomy. It is a misleading policy choice, as this column has often said, formulated and fed to electorates by opposition politicians and their pet intellectuals. “Economic growth” isn’t a choice that governments can make. It is, instead, a useful outcome that can be achieved in a variety of ways, none of which is guaranteed.
There are, on the other hand, many ways to make sure that growth doesn’t happen, and that a country’s economic situation gets worse. One tried and tested method, as Callaghan knew well, is for a country to borrow so much that creditors lose patience and refuse to roll over sovereign debts. Growth certainly won’t happen during the chaos of a creditors’ strike, when markets are in meltdown and interest rates spiraling out of control.
You won’t see growth, either, when inflation is soaring, as a currency plunges, after a nation has printed so much money that investors finally tire of debasement and cut that country loose. How can there be growth, too, amidst civic unrest, the result of a government being unable to make welfare payments, and keep vital public services running, because credit markets have collapsed? While there are few certainties in economics, the above no-growth scenarios are unarguable.
“Ah, but Britain is a safe haven”, the detractors cry. “Government borrowing costs are low so we can afford to spend more”. Where does one start when faced with such nonsense? The UK government can currently borrow cheaply partly because, when compared with much of the eurozone, we have a reasonably credible fiscal plan. We aren’t sticking to it, of course. Government spending between April and June was 2.2pc higher than the second quarter of 2011. Over the first six months of 2012, net public sector borrowing was £6.8pc above that of the same period last year.
The UK, though, is at least trying to toe the line, not provoking its creditors by thumbing its nose at fiscal caution. This absolutely must continue or the house of cards could collapse. For, be in no doubt, our gilt market is extremely fragile. Yields are low partly due to the eurozone mess, but mainly because the biggest purchaser of sovereign debt is the state itself in the form of the Bank of England. Circular financing can work for a while, but eventually the music must stop.
The “Old Lady” isn’t the only captive buyer. Gilt prices are also being propped up by state-owned banks and pension funds bound by “regulations” that amount to nothing more than a legal requirement to lose their policy-holders’ money. How can that not be the case, with yields close to nominal zero and inflation now at 2.6pc? The “safe haven” status of UK gilts, built on political bribery and group-think, simply can’t last forever. In the eye of the storm, the UK should be seriously cutting spending, getting ready for the un-wind, not using the temporary calm to justify another massive spending spree.
The reason the UK isn’t growing, anyway, has nothing to do with a lack of “pump-priming”. A bit more government spending here, an “enterprise scheme” there, may buy-off the odd interest group, but amount only to political parlour games, having zero impact on growth – unless, of course, the extra spending they entail tips international opinion over the edge and our bond markets seize, forcing us back into a deep, Lehman-style, slump.
The UK is refusing to grow for one main reason – because our banking system is broken. It remains broken because vast unaudited liabilities continue to lurk within banks’ off-balance sheet vehicles, ensuring that the inter-bank market remains paralyzed by fear of counter-party risk. As such, the availability of finance remains rock-bottom. The annual rate of UK bank lending just dropped from -4.7pc to -6.2% – a record-low.
Credit-worthy firms and households are being starved of the working capital that is the very essence of enterprise. That’s why we have no growth. I don’t buy the banks’ line, either, that no-one is seeking finance. That strikes me as propaganda, every bit as twisted as the Marxist clap-trap peddled by the industrial unions that destroyed Callaghan’s Britain. The bankers, in fact, have damaged the country even more.
Calling for “growth” isn’t difficult. Taking on the banking lobby, though, requires serious knowledge and the courage to face-down powerful vested interests. What a tragedy it is that the Western world seems to lack the leaders, or even the intellectuals, with the necessary guts.