Growth is at best weak, at worst non-existent, after a black Friday in which British and eurozone manufacturing slumped and America’s job market stalled, with the unemployment rate up. Yields on gilts — and US treasuries and German bunds — are at record lows. The 10-year gilt yield is under 1.5%.
So why doesn’t the government do what Paul Krugman, the nearest thing to a rock-star economist, advocates? Krugman, on a visit to Britain from America, put it in his usual colourful way in a lecture at the London School of Economics and in numerous BBC interviews.
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“If you want to worry about debt and deficits, fine, but this is the time, to quote St Augustine, to say, ‘Oh Lord, make me chaste and continent, but not yet’,” he said at the LSE, adding: “The bond market is saying borrow, borrow.”
It is a view with many advocates here. Government borrowing is cheap. Why not follow the advice of a group I could call Keynesians but will call the borrowers?
Many people get confused in this debate, because there is a lot of confusion around. Jon Moulton, the venture capitalist, thinks the government should cut spending even harder. I shall leave that for another week.
The first confusion is over the causes of weak growth. Some borrowers imply it is all down to austerity, notably coalition austerity. But it is caused by a range of factors, including austerity but mainly high commodity inflation (squeezing real incomes), the eurozone and the credit crunch.
I asked the Ernst & Young Item Club, which uses the Treasury model, to compare growth under coalition plans with Labour’s plan for slower deficit reduction.
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Cutting the deficit has worked every time before. If there was a UK economic policy textbook, this is page one, chapter one The results are interesting. The economy grew 2.1% in 2010 and 0.7% in 2011, and Item projects it will grow 0.4% this year. Under Labour’s plans, assuming nothing else changed, growth would have been marginally higher in 2011, 0.8%, and in 2012, also 0.8%, but at the cost of about £24 billion of additional government debt.
Item suggests, however, that it is realistic to assume gilt yields would have been 0.5 percentage points higher under Labour’s plans. They fell this much between the March 2010 budget and George Osborne’s June 2010 budget. Plugging this into the model gives 2011 growth of 0.7% (as under the coalition), and 0.7% in 2012, only slightly faster than now expected, though with an additional £37.5 billion of debt.
Yes, I hear you saying, but what if there was no austerity at all? Let me turn to the National Institute of Economic and Social Research, which is in the borrowers camp.
In May last year, it predicted 2% growth for 2012. Now it predicts zero. There has been no “news” on 2012 fiscal policy in the past year; the IMF suggests a modest loosening relative to previous plans. So other factors explain the shortfall.
The second confusion is over historical precedent. You might think cutting the deficit is some mad, ideological experiment. There is an excellent new Centre Forum pamphlet, Delivering Growth While Reducing Deficits: Lessons from the 1930s, by the economic historian Nick Crafts.
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Starting from much lower budget deficits than now — roughly 2% to 3% of gross domestic product — the then coalition acted to restore budget balance.
“Over fiscal years 1932-33 and 1933-34 the structural budget deficit was reduced by a total of nearly 2% of GDP as public spending was cut and taxes increased, the public debt to GDP ratio stopped going up while short-term interest rates stabilised at 0.6%,” Crafts writes. “Yet, from 1933 to 1937 there was strong growth such that real GDP increased by nearly 20% over that period.”
As in the 1930s, so in the post-1976 period, the 1980s and 1990s. This is no laboratory experiment. It is what has worked every time before, combining fiscal consolidation — cutting the deficit — with loose monetary policy and a devaluation of the pound. If there was a UK economic policy textbook, this is page one, chapter one.
The borrowers, on the other hand, suggest something for which it is hard to find a British precedent. Public borrowing is close to peacetime records. Borrowing in 2011-12, 8.2% of GDP, would have been a record if not for even higher figures (11.2% and 9.3%) for the two previous years.
Labour had a time-limited fiscal stimulus worth £25 billion in 2008-9, when the deficit was 6.9% of GDP. But I can find no example of a British government, faced with high borrowing and having embarked on a fiscal consolidation, reversing it.
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Things might be different if, as discussed last week, everybody agreed that most of the deficit is cyclical and not structural. They might be different if the eurozone produces a second collapse, though the deficit consequences of that do not bear thinking about.
None of this means the borrowers are necessarily wrong. The case for a stimulus does not rest on whether austerity caused the weakness. The lack of precedent may be because this time it really is different.
But what they are proposing is risky. A ratings downgrade is not the end of the world but Moody’s, in its January warning on the AAA rating, said a “discretionary fiscal loosening” would be a likely trigger.
Markets see Britain as a safe haven but that is not guaranteed. They can turn on a sixpence. Pimco, the bond firm, once had gilts “resting on a bed of nitroglycerine”.
The Office for Budget Responsibility, having pushed the government into a further fiscal tightening, would find it hard to condone a loosening, even one that focused on capital/infrastructure spending. The government has two fiscal rules, on the current deficit but also on debt.
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I urged the Treasury last year to find room for more infrastructure, but strictly within the existing fiscal framework — without more borrowing — and it did in the autumn. The IMF wants more, again without raising borrowing. I agree, though planning delays mean it is hard to get projects going quickly. “Shovel ready” projects are not lined up in Whitehall waiting to go.
What makes me most uneasy is government debt. Some borrowers say anything borrowed now would be strictly temporary. But clawing it back later would be hard, with the government already needing to find substantial extra welfare savings.
Public sector net debt is 65% of GDP, excluding the liabilities of the state-owned banks, or 148% including them, says the Office for National Statistics. Eurostat, the EU statistical agency, puts the figure at 87%. Whichever measure you use, it is rising strongly and those banking liabilities may yet return to haunt us.
When does it become unsustainable? An influential paper by Carmen and Vincent Reinhart and Kenneth Rogoff, entitled Debt Overhangs: Past and Present, argues that, tempting though borrowing may be, governments should tread carefully.
Once debt gets to more than 90% of GDP, the “overhang” consequences can become severe: annual economic growth more than a percentage point lower, sustained for an average of 23 years. As they say, “the cumulative effects can be quite dramatic”. This is something to avoid.
What should the government do instead of more borrowing? A lot more to ease the impact of the credit crunch on business lending and mortgage markets. Freeing up credit provides demand. The great housebuilding boom of the 1930s was founded on easily available credit and an absence of planning. I shall return to this.
• What can you, as an individual, do to soften the impact of Tuesday’s welcome but economically damaging extra bank holiday? As things stand, it could mean a third successive quarter of falling officially measured economic activity.
Short of battering on the workplace door and demanding to be allowed in to work, there is only one option. Spend, and preferably on British goods and services. It is the only patriotic thing to do.