Making economic policy when the convention wisdom is wrong and is against you is not easy, as Labour is finding. But conventional wisdom can shift rapidly. This week has seen some signs that may be happening. Labour still has work to do in crafting its economic policy however.
Bill Gross, the manager of the world’s largest bond fund, has changed his view on austerity. Having criticised the UK for being too slow in getting debt down, he now states the bond markets want growth. The Financial Times quotes him as saying:
“The UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not. You’ve got to spend money.”
The Coalition cited the dangers of a bond market sell-off when they announced in 2010 more stringent spending cuts than Labour had planned. I have often argued that while that did not make much economic sense, we could not ignore the risk that bond market opinion would move against the UK. That is why Labour has always to demonstrate a clear and credible commitment to control and reduce borrowing. I have also argued that bond market views can change rapidly. In The Credibility Deficit , a Fabian pamphlet published in 2011, I wrote that:
“If debt is reduced too quickly (cutting government spending, raising taxes) the economy may struggle to recover. This would lead to lower tax revenues and hence upward pressure on borrowing. At this point, markets will begin to fear a scenario in which debt is rising but growth is falling. Bond investors can change their minds quicker than governments can change their policies.”
That seems to be happening.
Predictions that high levels of government debt will lead to a significantly lower growth rates are not as sure as had been thought. The economists Carmen Reinhart and Kenneth Rogoff had suggested that, on average, when net debt rose above 90% of GDP, an economy’s growth rate would be noticeably slower. That conclusion has been challenged in recent days (prompting much debate). There seems to be no particular level of net debt which puts the brakes on an economy. Net debt as a percentage of GDP is negatively correlated with GDP growth, but growth does not suddenly drop off a cliff as net debt levels rise. In addition, the causation is unclear (ie lower growth could lead to higher net debt as a proportion of GDP).
The challenge to Reinhart and Rogoff matters because their work has been influential on policy-makers and much quoted. Those who were disposed to ignore basic macroeconomics and treat the economy like a household budget felt they had justification for their opinions (ignoring the caveats the authors included in their work). Unfortunately, such people have been in power, in government and the bond markets. It was of course John Maynard Keynes who memorably stated, in his General Theory, that:
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood…Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
The mood towards austerity is changing elsewhere too. The IMF last year had already revised its economic models and become convinced that austerity could be counter-productive. The President of the European Commission this week stated that the EU was at the limits of austerity. Germany appears to have relaxed its stance slightly. In the UK, the latest borrowing figures show that while borrowing has met the most recent target, compared with the Coalition’s June 2010 aspirations we are way off getting borrowing down. Borrowing is little changed from last year and is expected to be similar next. This puts pressure on the government to say just how it will boost growth and cut borrowing.
In left-leaning political circles there are attempts to free Labour from the impending straitjacket of George Osborne’s spending plans for after the General Election. The fear is, as I argued last year for LabourList, that if Labour adopts Osborne’s plans, in a replay of 1997, we will have conceded the macroeconomic policy agenda before we have started. The IPPR has suggested a new fiscal framework and the Fabian Society has just made an interesting case for allowing spending to be frozen or grow slightly in real terms. However, just because more people have realised that cutting spending and raising taxes in a depression is nonsensical does not mean progressive policy-makers can relax in long-established comfort zones.
What matters, it is worth repeating again, is that our economic policy must be credible. People need to believe we are serious about wanting to control borrowing levels and serious about controlling spending. That might mean we can spend more and differently than Conservatives plan, but only if we can do so sustainably and effectively. That points to new and clear fiscal rules, together with a guarantee, independently verifiable, that any spending beyond Coalition plans will be effective and not wasted.
Stephen Beer is an investment manager with the Central Finance Board of the Methodist Church and former chair of Vauxhall CLP. This article represents his personal opinion