The growth V austerity debate in wholly wrong
“Deficit reduction will lead to economic recovery,” say the Tories. “That is the heart of our growth strategy – getting our public finances under control”. The above paragraph, I would say, is a fair approximation of the UK government’s current economic policy – or at least, the Tory majority in government.
As regular readers will know, I have some sympathy for this view. This column has been warning about Britain’s impending budgetary ruin, and the danger of gilt market meltdown, for many years, not least during the mid- and late-2000s when David Cameron’s Tories were spouting opportunistic nonsense from the opposition benches about “matching Labour’s spending plans” and “sharing the proceeds of growth”.
Sorting out our public finances remains, by a long way, the UK government’s most important economic task. For all the “austerity” rhetoric, we’ve actually seen little overall spending restraint. Public sector net borrowing during the financial year to last month was £65.1bn, almost £3bn higher than the same period last year, according to official data released on Friday.
Despite signs of miniscule fiscal improvement, Chancellor George Osborne will still probably have to admit in his Autumn Statement in early December that he is on course to miss his medium-term fiscal target. Even if he hits it, this country will borrow a massive £120bn during the current financial year, with the outstanding stock of government set to triple between 2008 and 2015/16.
Did I mention that before? Oh sorry. But it needs to be said again and again and again. This horrendous fact – that our national debt will triple, even if the deficit goes to zero by 2015/16 – must be hammered into our often infantile political debate. For all that debt must be serviced, with the spiraling interest payments detracting from spending on schools, hospitals, defence and the other public services our country obviously needs.
Ministers claim that financial markets are “rewarding” the UK by demanding only low yields when lending the government money. I so wish that were true. For it is only the virtual money-printing that we’ve seen on an unprecedented scale – a grotesque, kleptocratic policy, which is storing up untold future problems – that has prevented a catastrophic creditors’ strike. That, and the fact that the markets, for now, are focused on the eurozone.
The UK remains in grave danger of a sovereign bond market meltdown. This is a reality that few in the Westminster village want to hear. Were it to happen, Britain would certainly endure an inflation spike, a crippling rise in borrowing costs and a break-down of vital public services. Predictions of civil unrest wouldn’t be wide of the mark.
So, we absolutely need fiscal consolidation – and genuine consolidation, that actually tackles our budgetary woes, going beyond just rhetoric. Crucially, we also need the right sort of fiscal consolidation focused on reducing current spending, rather than on cuts in public infrastructure investment which, if responsibly financed, can bolster growth. Unfortunately, this is the precise opposite of what the government has been doing.
This point was brought home to me powerfully last week by Professor Nicholas Crafts, in a lecture hosted by the Royal Economics Society in London. Crafts, who runs the Centre for Competitive Advantage in the Global Economy at the University of Warwick, is among our most astute academic economists, specializing in combining historical analysis with detailed empirical work.
Between 2009/10 and 2016/17, government spending is set to increase from £661bn to £709bn, according to official figures cited by Crafts, with annual social security payments rising 22pc to £199bn, and debt interest costs soaring by a staggering 107pc to £64bn a year (and that’s on benign interest rate assumptions, assuming credit markets don’t revolt).
Net public sector investment, in contrast, will plummet 55pc, to just £22bn per year. Pointing to compelling evidence from previous budgetary retrenchments, Crafts asserts that “fiscal consolidation is necessary of course, but it needs to be far more productivity-friendly”.
In other words, what’s needed to secure growth isn’t demand management, but a combination of public infrastructure spending and radical supply-side reforms. Yet rather than tackling entrenched vested interests and taking the really tough decisions on welfare payments, and other areas of state-sector largesse, the government has taken the easy route of slashing future public investment. This is a serious mistake.
Between the start of 2010 and the second quarter of 2012, the UK economy has grown by just 0.9pc in real terms. In June 2010, GDP was forecast to expand by no less than 5.7pc during this period. It is hard to improve the public finances when growth is so much lower than expected.
Our paltry growth, though, has little to do with “austerity” – as the Office of Budget Responsibility confirmed in a little-noticed report last week. The UK economy is so weak because household consumption is stagnant, in part because real incomes have fallen amidst stubbornly high inflation. Growth is low because investment has stalled and exports have continued to disappoint.
Above all, growth is low because bank lending continues to sharply contract, with the UK’s banking sector still denying finance to millions of credit-worthy households and firms. This is the biggest and most damaging vested interest of all that ministers have failed to take on – namely, our moribund, zombie banks.
The UK’s political leadership is relying on deeply damaging policies such as “quantitative easing” and the odd half-hearted “scheme” to boost growth. But no amount of QE, and no other “eye-catching initiative” will allow the British economy to get back on track until the banks are restructured and the enormous losses that lurk on unaudited parts of their balance sheets are written-off.
“I’m the Chancellor in a government that has done more to reform finance and banking than any before it,” said Osborne at the recent Conservative party conference, citing the Vickers Commission and the “ringfence” that will be established within the UK’s financial monoliths to separate investment and commercial banking. It was the co-mingling of such activities, with bonus-fuelled traders gambling with ordinary punters’ deposits, while enjoying an implicit state guarantee which, more than anything else, caused the financial mess we are in.
It strikes me that Osborne’s claim to have “reformed” the banks is a long way from the truth. Last week, Paul Volcker, the former Federal Reserve Chairman who has fought to introduce a full “Glass-Steagall” separation of investment and commercial banking in the US, a fight he could yet lose, gave his verdict on the UK’s reforms.
The Vickers ringfence is “full of holes … that are likely to get bigger over time,” said Volcker. “The concept that different subsidiaries of a single commercial organization can maintain total independence either in practice or in public perception is difficult to sustain”. Oh – and the Vickers measures won’t be binding until 2019, giving our vociferous banking lobby plenty of time to water them down even more.
This coming Thursday, the Office for National Statistics publishes its preliminary estimate of UK growth between July and September. If these third quarter numbers confirm that Britain is still in recession, and even if they don’t, their publication will mark the start of yet another chapter in the absurd “growth versus austerity” debate. That discussion is based on a false dichotomy and is anyway a diversion from the real issue. For the only way genuinely to fix the UK economy is to fix the banks. I’ve said it before and I’ll say it again: there really is no alternative.