Six nations economics and the downgrade

23rd February, 2013 1:48 pm

Imagine economic policy was a six nations game. The Moody’s downgrade is essentially a crunching tackle. George Osborne decided, instead of changing course, to try to charge through the opposition front line. The results were predictable.

Had he shown more awareness of what he was faced with, he may have slipped a pass back to a team-mate in order to seek another way round the economic man wall that he faced. The time to have done so would have been last year’s budget or, at the very least, the autumn financial statement. He didn’t.

A sensible measure would have been to use the UK’s sound debt rating and low borrowing costs to borrow to invest in infrastructure and housing. He might have shifted government spending further away from current spending to capital spending too to try to garner growth. Instead, he ploughed on and a Lewis Moody style flanker has pulled him to ground.

An economic report from Citigroup yesterday illustrated graphically what has happened since the publication of George Osborne’s ‘infrastructure plan’ in 2011:


Not much of a plan then. Citigroup’s Michael Saunders is convinced that Osborne will finally borrow somewhere in the region of £5billion-£10billion to invest at the time of the budget in March. However, if Osborne simply gets to his feet, post Moody’s tackle, and charges again then the result will be the same. Now that the IMF has shifted its assessment of fiscal multipliers in a downturn, the economic calculations should be very different. The downside risks of overly rapid consolidation are much greater as the Chancellor has found.

Intriguingly however, the downgrade actually frees George Osborne from the self-imposed ‘plough on regardless’ strategy. Like Norman Lamont after the UK’s ejection from the ERM, one of his fundamental objectives has been removed. This actually gives him much more flexibility: you can’t lose what you’ve already lost. Monetary stimulus alone is not up to the task – £375billion of QE has failed to lift the economy into growth and is starting to have some perverse effects as asset bubble begin to swell. Better to use fiscal policy too in the short term – high multiplier capital investment which has a limited impact on the structural deficit and larger impact on growth is best.

Where does this leave Labour? For a start, the triumphalism that has greeted the downgrade is hardly edifying. So the tone is all wrong. In terms of atmospherics, Labour might actually be better realising that people know we are facing a formidable front line and getting through is going to be tough. Some acknowledgment that recovery is as tough an economic challenge as we have faced for a century might actually fit the moment better. We are right and they are wrong is really grating – especially when Labour was in charge when this long recession began.

It won’t impress anyone.

Ed Balls has made some very good calls and his tone on the Today programme was fairly measured. He was consistently right to argue that a premature deficit reduction would have a bigger impact on growth than the OBR and the Chancellor were arguing. That is judgment rather than luck – credit absolutely due.

But if possession of the ball turns over to Labour what will be the outcome? There would be more short-term growth but there would also be more debt. The biggest chunk of the additional borrowing Labour proposes would go on a VAT cut that has a relatively lower fiscal mutliplier. The risks that we face through low growth would become currency and debt risks instead. It might work out all right – just as Osborne’s plan might have worked out better in more opportune circumstances (see the nature of the UK’s or Canada’s recovery in the mid 1990s for a different model of recovery from recession). But the key is flexibility. That is what Osborne has failed to demonstrate. Labour’s message could do with a far greater dose of humility – and the flexibility argument is central to this.

We have a Shadow Chancellor but there is no Shadow economy – an alternative reality where Labour’s economic policy is assessed. Looking at parallel examples such as the US experience is hardly a satisfactory proxy for assessing the UK’s position. It’s a hint and little more than that.

In very uncertain times, replacing one certainty with another is unwise. So the political and economic critique of the Coalition comes one of over-confidence and a lack of flexibility. Dexerity is necessary in this environment. ‘We won’t fall into George Osborne’ trap’ is a much better argument both politically and economically than the current ‘we’re right and they are wrong’.

In 2015, Labour could well be in charge of economic policy once again. Imagine a run on the pound or gilts or another Eurozone crisis or a shift in Bank of England policy. Suddenly things don’t seem so easy. It would be good to get a sense that instead of just bounding towards the front-line in an Osborne-esque fashion that Labour will instead think its way through a very tricky set of fiscal, financial and economic problems. I’d much rather have Labour’s plan than George Osborne’s right now. The lesson from the downgrade though is that economic plans have a chance of back-firing in times of uncertainty. Like rugby, economic policy is a game of brute force but it also requires finesse. This matters both politically and economically.

Labour’s challenge is to recognise this.

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