Feeling lucky, David?

By Anthony Painter / @anthonypainter

Brush away the foam of the ‘new politics’ and underneath this coalition, a hard core is revealed. It is summed up in a single word: ‘deficit.’ And of course they are right. Budget deficits in excess of 10% of GDP are unsustainable and there is no point pretending otherwise. The problem for David Cameron and George Osborne (and Danny Alexander and Vince Cable and the cat…) is that the direct route is not always the quickest.

While the coalition – and a tranquilised and sheep-like media – thrill at the way Canada reduced its deficit in the 1990s, there are other scenarios that may well apply. The attraction of the Canada scenario is threefold. It gives the Coalition a process – ‘star chambers’ and the like. It fulfilled its direct objective – Canada’s public finances to this day are amongst the healthiest in the world. And it achieved its indirect objective – growth returned to the Canadian economy.

The logic of Canada-style brutal, rapid and immediate deficit reduction was outlined by David Cameron in a rather predictable speech earlier this week.

David Cameron underlined the logic of the argument in Monday’s speech:

“If in Britain investors saw no will at the top of government to get a grip on our public finances, they would doubt Britain’s ability to pay its way.

That means they would demand a higher price for taking our debt on, interest rates would have to rise, investment would fall.

If that were to happen, there would be no proper growth, there would be no real recovery, there would be no substantial new jobs – Britain’s economy would begin an inevitable slide into decline.”

Now, you’ll notice the two ‘ifs’ in that quote. They are important. What if Canada’s success was not down to cutting the cost of investment, i.e. interest rates, and was down to something else? What if it was down to the proximity of a healthy export market that sustained demand for the output of the Canadian economy? What if the recovery of the Canadian economy and public debt was down to export sustained growth from a burgeoning US market to Canada’s immediate south and less down to ‘star chambers’ and the like?

And just say that had that export boost – facilitating an average growth rate of 3% in a decade that started off in recession – not been available to Canada, then growth would have stalled and their deficit would have remained stubbornly high. What scenario would it then have been looking at? It turns out that Canada’s is not the only deficit reduction scenario. There’s also Japan.

Two premature fiscal consolidations were attempted in Japan – in 1997 and 2001. Both times the result was disastrous and the policy had to be quickly reversed. Growth plummeted as did tax revenues and so the deficit increased rather than declined. Japan is fortunate that it has a huge savings pool from which to draw in order to finance its national debt. The UK is rather more reliant on the international bond markets. But the point remains. Reducing the debt had no impact on investment – interest rates were already low and demand for debt was low also as firms were deleveraging. So growth did not return and with demand extracted from the economy, debt ballooned again. Japanese national debt now stands at somewhere in the region of 200% of GDP. In the UK, it is at 68% (54% excluding the financial intervention – the bailout cash will probably be reclaimed.)

What if the scenario we face is Japan rather than Canada? It would be an economic and fiscal disaster.

Which scenario? There is no way of knowing; the road is scattered with risk and, even worse, complete uncertainty.

David Cameron does have it right that the deficit is a concern, though the more he talks about it being a crisis, the more that becomes a self-fulfilling prophesy. The problem is that there is a huge pool of global sovereign debt and the credit agency wolves, though no yet howling, are beginning to growl at the door.

The notion that the budget deficit was out of control before the crisis doesn’t stand up to any scrutiny. As this analysis on Left Foot Forward shows, revenues and current spending were in balance before the credit crunch. But we can’t just pretend that the current fiscal situation does not have to tackled – we don’t have a proximate booming economy to allow us to rapidly grow as was available to Canada. The question is how we tackle it most effectively and the direct route may turn out to be very congested.

For all his talk of ‘growth’ on Monday, the Prime Minister and his merry band haven’t actually got a growth strategy at all. Without a stronger narrative and strategy on where growth in the economy is going to come from (his speech was all critique and no proposition other than ‘cut the debt’) then the risk of cutting before the private sector is in a stronger position becomes greater.

It may come off but he should make no mistake. Slashing public spending in absence of growth or without a strong and credible growth policy is gambling on a Canadian instead of a Japanese scenario. Feeling lucky, David?

Anthony Painter blogs at http://www.anthonypainter.co.uk