Central bank easing continues as Reserve Bank of Australia cuts borrowing costs overnight, following European Central Bank’s move last Thursday
It is nonsense to suggest that Britain cannot afford not to invest in infrastructure. Now is just the right time to do so
Before 2008, an avowedly modernising Conservative party committed to match Labour’s public spending totals. However, two weeks after Lehman Brothers went bust in 2008, George Osborne took to the rostrum at his party’s conference and reverted to Tory type, sternly announcing that “borrowing is out of control”, and – recalling an establishment phrase from the Depression – promising to “put sound money first”. There is something ironic in this ancient echo, for – as we will show – the Osbornian claim that Britain is broke is dependent on eschewing the long view.
By the time the coalition was created, the early stirrings of a debt crisis in southern Europe lent superficial credibility to fears that Britain was teetering on bankruptcy. And so the cutting began, with the squeeze disproportionately concentrated on capital outlays, such as building projects. In just two years, net public investment almost halved from £48.5bn in 2009/10 to £28bn in 2011/12, and despite recent budget hype about renewing the infrastructure, the smallprint of the red book reveals that this net investment total will stay on the floor, averaging only £25.8bn per year during the first half of the next parliament.
The defining narrative remains that There Is No Alternative, because Britain is “broke”. But can this story be squared with the facts?
The figure below shows that UK debt/GDP was above 80% for most of the last 300 years. Enthusiasts for austerity tend to ignore the vast majority of that timeframe, focusing on the increase in debt from below 40% to around 80% of GDP in the last few years. But If Britain is broke at the moment, then the graph shows that it was also broke for a whole century between 1750 and 1850, and for 20 years after the second world war. In reality, in neither case did the UK default, and reveal itself as bust – both periods were times of investment, growth and national renewal.
Other advocates of austerity suggest Britain is broke because the cost of servicing debt is bankrupting us. However, UK debt interest payments are now actually lower as a share of GDP than at any point up to the year 2000. So if this is the yardstick for being “broke”, Britain has also been broke over the whole second half of the 20th century.
Of course, modest current costs would be of no comfort if they were liable to rocket soon. The reality, however, is that there is no sign at all of increased public debt pushing up public borrowing costs. Since the slump first swelled the debt in 2008, interest rates have drifted not up, but downwards. Most chancellors in the late 20th century would have given their right arm to be able to borrow at anything like the current 2%.
Furthermore, research by Jonathan Portes, of the National Institute of Economic and Social Research (NIESR) suggests that rates fell to such lows during this slump because the prospects for growth are so weak – not because austerity has persuaded investors that the UK is less likely to default.
All evidence, then, points against Britain being too bust to invest. But shouldn’t the UK still fear going the way of Greece – losing control of the public finances, and then – after a delay – being savagely punished by the markets.
Not really: the problems of Greece and other stricken continental economies arise because they have no flexibility to unilaterally loosen their monetary policy, owing to euro membership. In contrast, with its own central bank the UK enjoys more freedom to grow its way out of recession. Indeed – while inflation remains depressed – if the UK were in a tight corner it could simply print the funds required to avoid outright default.
Britain, then, is not “broke” – in any historical terms, it is ludicrous to claim that. As for Britain not being able to afford to invest, the truth is the exact opposite: with the cost of borrowing at historic lows, Britain cannot afford not to invest. As in the 1930s, George Osborne’s “sound money” philosophy is distinctly unsound economics.
• This mythbuster is part of a series co-ordinated by the New Economics Foundation and the Tax Justice Network. You can read the full length piece here
With the economy still in the doldrums, the chancellor is under intense pressure to come up with a Plan B. Here are his options
The threat of an unprecedented triple-dip recession hangs heavily over the preparations for George Osborne’s fourth budget. The economy has been going nowhere for two years and the chancellor has suffered the humiliation of a credit downgrade. When he became chancellor in 2010, Osborne promised four things: a robust recovery, a rebalancing towards investment and exports, a deep cut in the UK’s record peacetime budget deficit, and the safeguarding of the UK’s AAA status. He has delivered on none of these pledges and the rumblings of discontent on the backbenches reflect poor opinion polls.
Like most of those who have come before him, the chancellor is finding that running the Treasury is a tough task. His honeymoon is long over and he can ill afford a repeat of last year’s “omnishambles” of post-budget U-turns. As usual, he has not been short of advice for what to include in his hour-long address to MPs on Wednesday. Vince Cable, Liam Fox and Ed Balls have all put in their two penn’orth in the past week. So what is the chancellor likely to do?
1 Go for broke
Osborne may feel liberated now that Britain has lost its coveted AAA rating and thus decide to take a risk or two. For the past three years, the government has tried to cut the budget deficit in the belief that this will win credibility in the financial markets and allow the Bank of England to provide a boost to growth through rock-bottom interest rates and £375bn of money creation through the quantitative easing (QE) programme. The chancellor may decide – in the face of weak growth and borrowing on course to be higher this year than last – that the mix of policy needs to be changed. Cable has suggested that he should increase borrowing by £15bn to fund infrastructure projects. The thinking is that the demand boost from public works will lead to higher growth, an increase in tax receipts and – eventually – lower borrowing.
2 Get tougher
Osborne could decide that the slippage in the deficit reduction programme – the gap between revenue and spending is currently expected to be £99bn in 2014-15 against the £35bn forecast when the coalition came to power in 2010 – warrants even more draconian measures to repair the public finances. Borrowing is on course to be at least £5bn higher in 2012-13 than in 2011-12 once a number of one-off distortions are stripped out, and if the chancellor finds this unacceptable he could raise taxes, announce fresh cuts in public spending or take another hack at the welfare bill. Osborne’s preference up until now, however, has been to allow the “automatic stabilisers” to work. This means accepting weaker growth leads to a bigger deficit, and that tightening policy when the economy is struggling would be self-defeating.
Likelihood : 1/5.
3 Shrink the state to cut taxes
The right wing of the Conservative party and influential free-market thinktanks believe that radical measures are needed to lift the economy out of its zombie-like state. Fox gave voice to this strand of thinking last week when he called for a five-year public spending freeze to free up £345bn for tax cuts. This would require David Cameron to abandon the ringfencing of the budgets for the NHS, overseas aid and schools, while the cuts to welfare would be unacceptable to the Liberal Democrat wing of the coalition. Osborne would dearly love to be in a position to cut taxes, but will not be able to deliver a giveaway package this year.
4 Sit tight
Cabinet members have been briefing that the budget will be one of the most boring of recent times. Osborne, they believe, will announce that he his sticking to his deficit reduction plans but will provide the Bank of England – under governor-designate Mark Carney – with greater scope to ease monetary policy. From the moment he arrived at the Treasury, Osborne has dubbed himself a fiscal (tax and spending) conservative but a monetary (borrowing costs, QE, the exchange rate) activist. The smart money is on him making changes to the Bank’s mandate to allow Threadneedle Street to pay more heed to growth over the coming years. This could include giving the Bank a dual growth and inflation target, giving the monetary policy committee more time to bring inflation back to its 2% target or switching to a new target altogether.
5 Mix and match
The budget is one of the big moments in the political calendar. It is therefore inconceivable that Osborne will stand up, open his budget box, produce one sheet of paper and say that he is leaving the economy entirely in the hands of the Bank of England.
As usual, there will be an array of measures designed to get the economy moving. Annual tax receipts this year will be upwards of £600bn, giving the chancellor plenty of scope to move money around while sticking to his deficit reduction plan. In big-picture terms, this will mean changing the mix between capital spending – investment in the nation’s infrastructure – and current spending, the day-to-day costs of government. There will be more money for fixing roads and building houses, less for Whitehall departments and the welfare budget. There will also be one or two headline-grabbing measures, and there has been strong speculation that Osborne will raise the personal allowance for income tax to £10,000, scrap the planned increase in fuel duty and reduce taxes on business. With no obvious candidates for raising money, the chancellor is likely to fall back on the traditional sources of cash when the Treasury is skint – closing tax loopholes and cracking down on avoidance.
The government’s only option to turn around the flatlining economy is to produce a sizeable and serious stimulus package
The predicament George Osborne finds himself in this weekend, as he puts the final touches to his fourth budget, can at least partly be ascribed to the forecasts made at the time of his first budget. According to the “emergency” Red Book of June 2010, Britain would by now be enjoying a healthy recovery. The national income, or GDP, would have grown 2.8% last year and would rise by 2.9% this year. Unemployment would by now be drifting downwards; public debt would be about to peak. In short, a historic austerity programme would be well under way and the end would be in sight. While consumer demand was nothing to write home about, the UK economy would have been buoyed up by healthy exports and one of the biggest business investment booms in postwar history. And David Cameron’s Conservatives could look forward to reaping the rewards at the general election.
You don’t need an economics PhD to know that things haven’t worked out like that. Instead, GDP shrank in the last three months of last year and Britain will be lucky to see a 1% increase this year. Along the way, we may well fall into our third recession in four years – the so-called triple dip. Public debt is on the rise, and last year the chancellor gave up his goal of ensuring it would be falling come 2015. Far from being reformed, the banking sector is caught somewhere between a drive to improve its balance sheets and to lend more – and is not doing a notably good job of either, which is why the Treasury and the Bank of England are now engaged in drawing up ever more elaborate schemes to channel credit to small and medium-sized businesses. That said, the euro crisis and the chronic sickness of the domestic economy means that the corporate sector is too wary to invest and is instead sitting on historic reserves of cash. And politically, the most interesting fact this week came from an Ipsos Mori poll showing that voters trust an economic policy more if it is attributed to Labour’s Ed Balls rather than the actual chancellor – a dramatic reversal of the situation as it stood in 2010.
All this puts an incredible amount of pressure on Mr Osborne – pressure that he cannot hope to bear. Listen to Tory backbenchers, and No 11 must deliver a budget next Wednesday that at once stokes the economy, continues the reduction of the welfare bill and shores up the party’s electoral fortunes. There is no way the chancellor can deliver all three. The most likely scenario must be that he will instead deliver a package of measures that will see an increase in spending on road-building and other infrastructure – funded not by borrowing, but by nabbing cash from other parts of Whitehall. The government will term this a stimulus, but it will be no such thing; merely a reallocation of small pots of cash. Over his previous three budgets, the chancellor has tried to find extra money from outside government – such as foreign investors or pension funds. This time he may encourage local councils to borrow more to build more housing. And the final and most important leg of his strategy will probably continue to be relying on the Bank of England, under its incoming head Mark Carney, to run an ultra-loose monetary policy.
All this amounts to a continuation of the chancellor’s plan A, albeit not following it as strictly as before. As such, it will do little to turn around this flatlining economy. To do that, the government would need to engage in a proper stimulus – borrowing between £15bn and £30bn from financial markets (or 1%-2% of GDP) and ploughing half into job-creating public works (especially building council housing) and the rest into a temporary tax cut. Vince Cable is right that borrowing a small amount of money would not give financial markets a fright – especially when the bank has cornered the market in government bonds. At such low interest rates, a fiscal stimulus is eminently affordable and necessary. The only thing stopping it would be dogmatism.