Keynes once said (or perhaps said), “When the facts change I change my mind. What do you do, sir?” And that’s the thing about complex modern economies, the facts do change. It’s only a fool that fails to change their position as a consequence. Today, following a dismal GDP growth figure of -0.7% for the last quarter, it is clear that the facts have changed and if the Chancellor doesn’t radically change course well, then, he’s a fool.
The question for the Prime Minister today is whether his Chancellor is capable of changing course. If he is not then for sake of the economy, George Osborne should not and cannot remain in Number 11 Downing Street.
All of the engines growth have stalled. Essentially, Osborne’s gamble in 2010 was three-fold. Firstly, he would accept some lower growth in the short-term as the price of lowering the deficit (he was never explicit about this but it can’t have been missed). Then powered by a lower exchange rate, investment funds would shift towards business investment and export-driven industries. Moreover, confidence in a policy of sound money and fiscal restraint would drive recovery and after a few quarters, GDP would start to pick up. Essentially, he thought the economy would follow the pathway of the post-ERM exit recovery in the early to mid-1990s.
It hasn’t worked out that way but yet the policy hasn’t shifted. None of his schemes to increase investment have as yet worked. The rapid reduction of public capital investment in infrastructure and the like has had a devastating impact on the economy. This has been compounded by the desperate situation in the Eurozone – our main export market. Commodity prices haven’t helped either but that is not the main cause of the problems we face.
There are four sources of potential growth: exports, Government expenditure, households and private businesses. Households are economically insecure and heavily indebted. Private business has no confidence. Our export markets are in a dire state. Fiscal restraint has eliminated Government as a driver of growth. Essentially the UK economy is a jet with all of its engines stalled. I don’t need to spell out what happens if one or more of these engines is not reignited.
But isn’t the Government deficit unsustainable? Yes, it is but in the short-term there is actually room for manoeuvre. Jonathan Portes of NIESR has been arguing for quite some time that very low interest rates were not in jeopardy if the UK Government decided to borrow more in the short-term. He has won that argument conclusively – in a floating exchange rate environment with control over your money supply you have more flexibility over your fiscal policy. When your economy has just shrunk by 0.7% in a quarter it is time to use some of that flexibility.
Basically, holders of pound sterling – many UK pension and investment funds amongst them – are fairly locked in given the other global investment opportunities and exchange rate risk. It’s easy to get your capital out of Greece, Italy, and Spain as we have seen – hence negative interest rates on German Bunds. Moreover, there aren’t many AAA investment opportunities in the UK other than Government bonds. Strangely, Eurozone risk and lack of confidence in the UK economy have worked in favour of a more active fiscal policy . The inflation risk is minor in the short-term given spare capacity – assuming our productive base is not too damaged.
That doesn’t give unlimited scope to fiscal activism. There may be an inflexion point that hasn’t yet been spotted or a currency crisis if things are seen to go too far. Also, the flipside of low growth-low yield is the return of higher yields as growth returns. The UK is still going to have a heck of a lot of interest to pay on the debts after growth returns. So it makes sense to invest in a way that is time limited, brings forward investment that is needed anyway and adds to the productive potential of the economy. As the SMF has suggested this could be further augmented by shifting government spending form ‘low multiplier’ activity – eg pension relief at the higher rate – to ‘high multiplier’ investment.
A sensible growth plan would mix borrowing for investment with this shift to more productive public expenditure. It would make sense to widen our notion of ‘investment’ to include housing, skills and youth unemployment programmes as well as infrastructure. All of these areas have a positive economic impact beyond the immediate spend. There is one major programme that could pull all these elements together: a massive programme of construction.
Quantitative or credit easing could be used to capitalise house and commercial builders with corporate bonds as collateral. A fiscal boost could be added to build 100,000s of social and council homes. Planning laws would have to be reformed by emergency legislation – including a review of Green Belt where it doesn’t meet high environmental standards or serve its original purpose of creating a buffer around major conurbations. New housing should be powered by low-energy power sources with underwritten investment for power companies to facilitate that. 1000s of the young unemployed and older skilled workers should receive rapid skills training in construction followed by the guarantee of a job. New schools should be brought forward where needed as part of the construction effort.
This boost to the UK’s housing supply and economy would be for a defined period to really get things moving. In the 1930s, the UK economy actually recovered as a result of both leaving the Gold Standard and a major house building programme following a policy of cheap money. In the 1950s, Harold MacMillan as Housing Minister moved every impediment to get house-building over 300,000 per year for the early years of that decade – including through a New Towns Act which accelerated the process through additional funding. What’s so difficult now?
What’s difficult is that we have a failed Chancellor who has run out of ideas but lacks the vision and determination to reverse his failure. The biggest economic decision that can now be taken is his removal. That is not down to him. He is now waiting for luck to descend upon him. That’s not a policy. That’s desperation.