Debt, deficits and doom-mongering

By Andrew Lomas

The familiar lines of “clearing up Labour’s toxic legacy” versus “cutting too deep and too fast” reared their ugly, predictable heads again last week with the Tories attempting to get Presidential approval for their deficit reduction strategy whilst Labour tried to claim that the OECD didn’t back the government’s cuts programme. Neither attempt was all too successful; Obama was exceptionally clever to avoid endorsing the Osborne approach and the OECD retorted that the Times piece reporting their initial opposition was wrong. So far then, business as usual.

However, a piece of research highlighted on the FT’s alphaville blog last week painted a more depressing picture; that neither cutting spending or simply maintaining it in its present form are likely to yield any success.

The basis of this analysis centres on levels of borrowing (not just government but also private borrowing) and the numbers are frightening. In short, the UK has been on a credit binge since 2002, consistently borrowing over 10% of GDP. Current levels of public borrowing are simply maintaining the levels of private borrowing that existed before the credit markets dried up in 2007.

Now of course there are problems that arise from using a deficit in this way. Initially, the deficit was essentially financed by quantitative easing (QE); this injected some £150-200bn into the economy, counteracting an equivalent contraction in the quantity of money that followed the collapse of credit lines and arguably preventing the slump from becoming a crash. There is unlikely to be further QE (though a loose monetary problem is essential for the chancellor so as not to exacerbate the effects of fiscal tightening) meaning that the deficit must be financed through gilt sales. This is where the no-cuts approach encounters problems.

Deficit spending per se is not the evil that many on the right paint it as, providing that the debt that it creates pays for itself over time (i.e. is an investment). In simple terms, borrowing to spend is not an issue if the national debt grows at a slower rate than the economy as a whole (and let us pause to reflect that as a number, the national debt has pretty much always increased year on year). The problem for the no-cuts brigade is that we are not borrowing to invest but rather financing current spending on all manner of non-productive items, commitments that were made before the tax base collapsed. In short, it makes buying UK debt riskier because the things we’re spending the borrowed money on reduces our ability to service that same debt over time.

The story isn’t rosy for the pro-cuts side either. Growth is an essential element to a speedy deficit reduction strategy and the report highlights the debt-dependence of the sectors that the UK economy will have to rely on in order to grow our way out of a hole. To put it mildly there are not encouraging signs for growth; consumer borrowing is likely to remain depressed with implications for a previously buoyant retail sector, mortgage lending is down with an inevitable impact on construction firms decisions on whether to build more homes, and companies are still complaining about their inability to access credit.

All things considered then, there’s an element to this that reflects the old maxim that debt is merely delayed spending. If this is the case, we face a future of retrenchment and falling living standards as people pay off the debts accrued in the last decade and firms find it impossible to access the finance they need to expand. Whilst this might make economic sense, it is politically unpalatable to allow the country to stagnate. The question therefore is what is politically (and economically) possible to try return the UK to some semblance of normal growth?

Whilst deficit reduction is an important component of the equation (at any pace), there needs to be a real strategy for growth; the Tories have come in for repeated criticism in this regard and there is a real opportunity for Labour to score some points. But it’s not enough to talk about a plan B if plan B contains nothing but empty rhetoric.

Firstly, every effort must be made to agitate for greater lending to businesses; nearly four years after the crash the availability of capital remains scarce. The city is hugely important in this process, so it’s time to tone down some of the more egregious banker bashing whilst working towards a financial system that promotes long-term investment rather than leveraging for short-term gain.

Secondly, there needs to be an end to the idea that social democracy can be predicated on the assumption of eternal growth; it can’t, yet repeated Labour governments have come unstuck in a downturn. There needs to be a reappraisal of what we can and can’t afford at the moment, and what is desirable in the future; this is going to involve some pretty painful decisions, especially when it comes to welfare spending. The guiding principle should be that of minimum regenerate-able capacity so services aren’t lost altogether and can be regrown when finance allows.

Thirdly, Labour needs to champion the idea of a strategic state; not a government that meddles endlessly, but one that identifies long term economic challenges and responds accordingly. In the context of the deficit, the question is what kinds of things can the government spend on now that will lead to increased growth in the future? Clearly infrastructure like roads, railways, runways and power-stations are important. Probably rectifying the UK’s skills gaps by investing in decent post-16 vocational education rather than trying to get everyone to university. Maybe accepting that given the huge subsidy and inefficiency of our rail network that renationalisation isn’t a crypto-Bolshevik move but one that is likely to actually deliver a better service. And critically, working out a way to create employment in depressed areas that is more creative than simply moving public-sector jobs out of London.

Lastly, once the immediate crisis has passed, there must be attempts to tighten up monetary policy in a way that keeps credit lines to business open whilst preventing another consumer debt binge; that will be a difficult circle to square. The other side of this coin involves a massive house-building programme, both to meet massive unmet need, but also to depress the rises in house prices that were driving much of the irresponsible mortgage lending over the past decade.; a land-value tax might also be helpfully anti-inflationary in this regard.

In short, the economic picture is pretty gloomy for HM Treasury and the chancellor and a change of course is required. However, for Labour to look credible, we must now look beyond calling for a plan B to thinking about what such a plan would entail.