How to explain the government’s economic recklessness

By Asher Dresner

The government justifies austerity on the basis that it will help the economy grow. But not only will it cause hardship, it is likely to do the exact opposite – make the economy shrink. Here’s why.

When the economy is doing fine, there are loads of ways it can grow by itself. Money can flow into it from trade, a gradual devaluation, an interest rate fall, or from private investment.

For the last few years, though, the economy hasn’t been able to grow by itself. Quantitative easing and government spending have been the only things drip-feeding money into it.

Government cuts now mean suddenly yanking the economy off the drip. I’m no economist, but it seems to me that the government is yanking the drip away before the patient is ready to take in money any other way. Because right now, there’s nowhere else that money could come from.

Why not? Well, consider the options.

Trade – In normal times, money could come in from selling more to other countries. In the nineties, Canada and Sweden managed to cut and still thrive like that because the world economy was booming.

But now, most of our trading partners are in the exact same situation as us, or worse. We can have the best store in town, but if all our customers are broke, we won’t make any money. Besides, Britain’s net trade has actually been negative for the last thirteen years. It’s hard to believe that it will suddenly now grow fast to replace the money the government is taking out of the economy.

Devaluation – In normal times, we could let the pound fall so the rest of the world has an incentive to buy British. But we can’t do that now because pretty much every country’s currency is falling too. We’d get no competitive advantage from it, so we can’t replace the money the government’s taking out that way.

Interest rate fall – In normal times, we could lower interest rates. But we can’t do that now either: interest rates can’t go any lower. In fact, they’re the lowest they’ve ever been…since 1694. So we can’t replace the money the government’s taking out that way either.

Private sector investment – In normal times, money could come into the economy from, for example, Vodafone investing in new 4G technology or GlaxoSmithKline investing in new drugs.

But the private sector just doesn’t invest enough to replace the money the government’s taking out of the economy. To do so, it would suddenly have to start investing three times as much for the next three years as it had been doing on average each year for the whole decade between 1999 and 2008, (according to the OBR, table 1.2). And those were boom years.

In short, the government is taking away the drip-feed of money into the economy at a time when there doesn’t seem to be any way to get enough back in. The cure is likely to starve the patient.

Austerity’s advocates argue that it helps the private sector raise money in the long-term (because, for example, it reduces government bonds’ interest rates relative to private sector interest rates, so in the same way as you might shop around and choose a bank account with the best interest rate, lenders now prefer to lend to the private sector rather than the government). But this only happens in the long-term. So, this argument doesn’t justify cutting so fast that growth is endangered.

Austerity’s advocates also argue that austerity brings confidence, and confidence brings growth. But the evidence (here) is against them. To summarise: look at Australia, Belgium, Denmark, Ireland, Portugal, and Sweden in the eighties or Finland, Germany, Italy, Japan, and the US in the nineties. Their lesson is straightforward: the more money the government takes out of an economy, the more the economy shrinks.

That means more businesses shutting, more families having trouble paying the bills, more people signing on as unemployed, and more misery. And all this is before we mention that the government’s plan relies on leaving mountainous private debt to future generations.

Even besides the effect of the cuts themselves, that is why the government’s plan for the economy is so jaw-droppingly reckless. It is reckless to make the public sector fire people before the private sector is ready to hire people, reckless to ignore the lessons from other countries, reckless to encourage even more debt, and reckless to do it all without a plan B.

So as well as making the case about the damage cuts will do, Labour should start explaining why they are likely to shrink the whole economy, too. I honestly hope I’m wrong, but it looks like by yanking the drip out before it’s ready to feed itself, the government is going to starve the economy of the money it needs to grow.