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March 14, 2013 6:11 pm
From the loss of triple A to the edge of a triple dip, the backdrop to Britain’s annual Budget next week could hardly be more difficult. Seen from the US, the UK appears to be a prime example of the folly of excessive austerity; seen from the core of the eurozone, Britain’s economic woes demonstrate the single currency cannot be the root of all the continent’s problems. The 2010 global poster child of recovery and budgetary prudence has been sent to the doghouse.
Britain’s economy has grown only 0.7 per cent since the third quarter of 2010 and is quite likely to suffer another two consecutive quarters of contraction when the national accounts for the start of 2013 are published next month. Worse, public finances have forced ministers to extend the planned five-year deficit- reduction plan to eight years; the burden of public sector debt is not expected to start falling until 2016-17 or even 2017-18. External bodies are losing faith, with Moody’s downgrading the UK’s triple A credit rating last month and the other rating agencies expected to follow suit.
The Labour opposition can hardly believe its luck. Ed Balls, the pugnacious shadow chancellor, likes to taunt George Osborne, the chancellor, that his austerity has caused the economic woes and is deranged.
“‘Doing the same thing over and over again and expecting different results.’ That was Einstein’s definition of insanity,” he says.
And yet, at the heart of the coalition government, the most senior ministers accept the economic record is poor but are more convinced than ever that they are on the right track and things will soon be looking up. David Cameron, the prime minister, tried to give the chancellor political cover this month, pronouncing: “This month’s Budget will be about sticking to the course because there is no alternative that will secure our country’s future”.
In this dialogue of the deaf, the complexities of Britain’s economic situation rapidly get lost. But they are crucial for understanding what has gone wrong, the most likely outlook for the economy and the right policy prescriptions. Britain’s economy since 2010 is far from a simple case of austerity hitting household incomes and spending much more than the coalition government expected.
The recovery of gross domestic product – goods and services produced – has undoubtedly been the worst of any in the past century. Output remains 3 per cent below the peak achieved in 2008. But unlike the US economy, and unlike all recessions past, employment has surged ahead. In employment terms, rather than the deepest and longest downturn, the post-crisis period has been the shortest and shallowest. The consequence is that productivity – output per hour worked – has plunged.
The Treasury’s favourite explanation for this productivity puzzle is that the pre-crisis UK economy masked deep-seated weaknesses that the crisis exposed. Looking in detail at the areas of the economy that explain the productivity drop, aides to the chancellor say that not much short of half of the problem comes from two sectors: oil and finance.
North Sea oil is dwindling, with output down almost 40 per cent since the coalition assumed office in 2010, while the number of people needed to work the offshore drills has not decreased. Similarly in finance, the way the UK measures the output of the financial sector – to a significant degree by the size of banks’ balance sheets – ensures weakness as banks are forced to retrench without much labour shedding.
The Office for Budget Responsibility, the public finances watchdog that produces the official forecasts, has an alternative decomposition to explain the poor performance of output compared with its forecasts. Although Robert Chote, its fiercely independent director, tore a strip off the prime minister last week for his suggestion that the OBR had said austerity had not harmed growth, the OBR believes that between 2010 and mid-2012 austerity was unlikely to lie behind its massive over-optimism on growth.
After studying its forecast errors in detail last October, Mr Chote concluded that “unexpectedly stubborn inflation looks a better proximate explanation for weak real consumption in 2011 [than a larger than expected effect of austerity] ... and deteriorating export markets seem to offer a better explanation for the more recent weakness of net trade”. Six months on, the OBR’s explanation has gained weight because more recent data show all of the disappointment in 2012 being caused by terrible export performance, again driven by financial services rather than weak domestic spending.
In this more complicated world with a budget deficit still about 8 per cent of national income, economists struggle to come up with the simple policy that will kick-start a normal recovery in output as well as jobs.
Carl Emmerson, deputy director of the independent Institute for Fiscal Studies, says: “The public finances are in a terrible state although there is no need to panic. The government can say borrowing is down a quarter but it is still very high historically and internationally. Those that want more stimulus are arguing that [the government] should be doing a lot more on top of the existing stimulus.”
Many disagree with this view. Regardless of the cause of weak growth, a large group wants more fiscal stimulus. They point out that the government’s fears of adverse market reaction from the likely higher borrowing were overblown and that with its borrowing costs so low, there could not be a better time for fiscal stimulus to boost growth.
David Cameron set the backdrop to next week’s Budget in a recent speech in which he adopted the classic Conservative defensive posture: quote Margaret Thatcher. He insisted “there is no alternative”, writes George Parker.
But as the UK prime minister was reminded in the House of Commons this week by Labour’s Tom Blenkinsop, a vicious debate is swirling around his party. “Is he aware that his backbenchers and some of his cabinet believe there is an alternative to him?”
In calling for a £30bn immediate boost to public investment, equivalent to 2 per cent of GDP, Jonathan Portes, director of the National Institute of Economic and Social Research, says: “The halving of public sector net investment especially is now almost universally recognised as a major policy error”.
Stephen King, chief economist of HSBC, counters the argument that low borrowing costs prove the case for a further fiscal stimulus. If that were true, “we’d have to conclude that the Spanish, the Portuguese and the Greeks didn’t borrow anywhere near enough in the years before the global financial crisis”.
“More government borrowing at this stage, allied with quantitative easing, may not lead to higher [government bond] yields but will surely depress sterling. Sadly, the evidence to date suggests that currency weakness has only hit real household incomes without any of the hoped-for boost to exports,” he said.
Ministers feel they have no room for manoeuvre. Mr Osborne is boxed in on the economics but also, crucially, in the politics. Any deviation from his Plan A would be seen as an admission of failure and almost certainly the end of his political career.
Fearing accusations of staggering complacency from his political enemies – from the official Labour opposition and the unofficial opposition from his critics on the Conservative right – Mr Osborne has been trying to make a virtue of necessity, presenting himself as a flinty-faced helmsman with his hand firmly on the tiller.
In the run-up to the Budget, a sense of political claustrophobia seemed to be taking its toll on Mr Osborne and Mr Cameron, both of whom appeared to be showing signs of incipient panic. One Tory minister complained that they were starting to “overpromise and underdeliver” in a fashion they used to decry in Gordon Brown, the former Labour prime minister.
At a cabinet meeting last month, ministers were challenged repeatedly by Mr Cameron and Mr Osborne to prove their commitment to growth by announcing ambitious targets – for example, the rollout of high-speed broadband – which were deemed by ministers to be totally unrealistic. “It was starting to look very Gordonian,” said one minister.
Nick Clegg, the deputy prime minister and leader of the Liberal Democrats, was, according to Downing Street officials, among those urging Mr Osborne to calm down and “to act like a Conservative chancellor” and to play it safe.
His last mini-Budget was, after all, only last December and it was time to confront his critics with the reality that the March 20 statement was not going to be transformative for the economy.
So this year’s Budget will seek to be limited in scope with Mr Osborne’s package pared down to its bare essentials. There is also a sense – frequently articulated around Whitehall – that Mr Osborne’s speech will be far less significant than the monetary policy shift that is expected to attend the arrival of Mark Carney, the governor of the Bank of Canada, as governor of the Bank of England in July.
“It’s not about when George stands up but when Carney sits down,” said one government official.
“There’s no magic bullet,” said one aide to Mr Osborne. “It’s about going further in dealing with the deficit, making the economy more competitive and helping people when you can.” A package of measures to ease living standards – including a freeze on fuel duty rises and a £10,000 tax-free personal allowance – is expected to feature. Fiscal consolidation will be married to monetary activism and supply-side reforms.
The chancellor’s allies remain convinced that, with a steady nerve, a ‘normal recovery’ is in sight and should begin around the middle of the year
Mr Osborne’s team says the chancellor has been helped by an ability to position himself midway between the widely differing alternatives to Plan A being offered by his critics. Those on the Tory right want to cut spending further (a proposal deemed insane by the chancellor), while Vince Cable, the business secretary, wants to borrow more to increase capital spending on schools and hospitals.
But Mr Osborne also believes he is lucky in his enemies. Ed Miliband, the Labour leader, and Mr Balls, who both worked at the Treasury under Mr Brown, have put forward a prescription of more borrowing to boost growth that is incomprehensible to ordinary voters.
The chancellor’s allies remain convinced that, with a steady nerve, a “normal recovery” is in sight and should begin around the middle of the year. They point to signs of easing in financial conditions in the housing market, gently rising house prices, improving business surveys and less stress in the eurozone. They hope to see growth of about 0.5 per cent a quarter starting in the second half of the year and point to forecasts from the IMF showing a faster recovery than in the rest of Europe.
Once in place, they believe that the political dynamics will then change dramatically, stripping Labour of its key message that Plan A has been a complete failure.
This is keeping the Treasury happy. Officials should remember, however, that this was exactly their feeling a year ago when economic forecasts appeared to be stable and then deteriorated as 2012 progressed.
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