The next election is not about cuts – it’s about judgement

The Labour movement column from Tokyo

By Anthony Painter / @anthonypainter

A year ago Lehman Brothers collapsed. The response was resolute. The British government – the Prime Minister and the Chancellor – acted with alacrity and with profound understanding that this wasn’t just a passing storm. It had the potential to become an unprecedented financial and economic calamity.

A year later and shocking levels of complacency have returned to the political, media, and economic establishment. The most significant manifestation of this is a completely self-indulgent and Opposition driven obsession with ‘cuts.’

The government dragged the economy back from the brink. We are still paying the price in increasing unemployment; our assets and businesses are still under enormous strain and at risk.

An Opposition that has opinion poll leads in the mid-teens – but that has called everything wrong on the credit crunch, that still continues to miss the fundamental point, that could be in charge of the economy within a year – drives a political agenda that could force the economy off the road completely. The media willingly plays along.

You are never a hero for averting a crisis. The Prime Minister knows that only too well. That should not mean that the fact that a crisis does seem to have been avoided should not be acknowledged. This is not to give political credit where political credit is due. Though that would be nice. It is to understand what has happened and is continuing to happen to the economy so the worst does not beset us after all.

The most ridiculous aspect of this situation is that we have a historical example at hand of what can happen should fiscal policy be retrenched too early. As it happens, it is better to err on the side of incaution following a large explosion of an asset price bubble. That example? Japan in the 1990s and early 2000s.

As Richard C. Koo has written:

“There are few things as dangerous as premature attempts at fiscal consolidation during a [balance sheet] recession.”

A balance sheet recession is characterised by a major decline in demand for debt following the bursting of an asset-price bubble. The credit crunch had the potential to become such a recession and would have done had not a strong mix of monetary and fiscal stimulus been undertaken. And it could still happen.

How do we know? Well, fearing a ballooning Japanese deficit – a consequence of the bursting of share and property bubbles in the early 1990s – the Hashimoto administration decided to retrench Japanese government spending in 1997. What happened? The economy plummeted into the worst post-war meltdown and a credit crunch was precipitated. Tax revenues collapsed and the budget deficit soared – so much for fiscal consolidation.

Just to make sure we received an absolutely clear message should our own economy be beset by similar issues, the Japanese government tried the trick again in 2001 under Prime Minister Koizumi (who saw himself as a kind of Japanese Ronald Reagan/ Margaret Thatcher hybrid.) He placed a cap on the deficit.

The result? Tax receipts shrank, the budget deficit increased, and the target was dropped at risk of crippling the economy once more.

Luckily, though there are obvious differences and subtle variations in approach, most of the people in power in countries impacted by the current economic situation have read and learned the lessons of the Japanese economy. In a second Japanese post-war economic miracle, it has managed to mostly continue to grow over the last two decades.

It could have collapsed as the American and German economies did in the early 1930s (both with governments who initially rigidly insisted on balanced budgets.) The circumstances were remarkably similar but the US economy halved in size and ended up with 25 per cent unemployment. That hasn’t happened to Japan but could so easily have done.

There is one set of policy makers who haven’t read any of this recent history let alone the more distant economic history. They are the people who, having misjudged every big economic decision over the last two years, now want to be given responsibility for managing the economy for real. That is Her Majesty’s Opposition.

Margaret Thatcher was fond of comparing government finances to those of a household. It had some merit as an analogy but was largely misapplied. Of course, current expenditure should balance over a period of time. However, like households investing in property or buying a car so that they can access better work opportunities, governments make investments too. In the case of government that includes education and skills, infrastructure, science, energy, housing and a whole manner of other things. That long-term investment is one function of national debt and is entirely sensible – it raises our incomes.

Of course, when times are hard, income falls and that makes keeping the family’s current budget in balance very tough. But life’s essentials still have to be consumed. That’s one reason why deficits grow in such times.

However, government debt is different to household debt in one important respect. In abnormal times it makes sense to counter-intuitively borrow to spend and invest. In normal times, such an approach is madness. But we are not in normal times at all.

And that is the fundamental error that David Cameron and George Osborne make. They fail to appreciate just how abnormal this economic situation is. It should be a once in every few decades event. The Japanese are not out of the woods yet after almost two decades. Their national debt is more than double that of the UK. God only knows what it would be had they not propped up their economy.

So all this talk of cuts – and it is disappointing to see the Government start to get sucked into it – is grossly premature. It is highly dangerous. Nobody knows how quickly the fiscal situation could recover as we are in unchartered waters. There are signs that tax revenues increase very rapidly following a situation like this one but that’s an optimistic scenario. But damage this recovery and we know they will worsen significantly as will the deficit.

Should the Conservatives secure an election victory that they crave but do not deserve, they will face a stark choice just as the Hashimoto and Koizumi administrations did. Either the economy or policy is jettisoned. Should George Osborne become Chancellor then I have a prediction. By his second Budget he will be in the midst of a panicked reversal of his Government’s economic policy.

That is the public discussion that Labour must provoke over the next few months. It should ignore siren voices and make the case – whatever the short-term data shows – that this recovery is far form certain.

Talk of ‘cuts’ is a fine hypothetical discussion but it’s not the primary issue. The real choice is between judgement and recklessness. It is this Prime Minister and this Government who have demonstrated that judgement.

Photo: Downing Street, Flickr