Are tax increases and public spending cuts wrecking the recovery?
Those who say “yes” are impressive, diverse and vocal. Ed Balls, shadow chancellor, argues that the coalition’s decision to cut “too far and too fast” is causing a vicious circle of stagnation and higher deficits. His views are backed by Amartya Sen, a winner of the economics prize established in memory of Alfred Nobel, distinguished columnists in this newspaper and 52 academics with a taste for letter-writing.
Yet the evidence for a causal link between deficit reduction and the economy’s recent woes is thin, if not non-existent. Blaming unexpected stagnation on fiscal consolidation is a monstrous confusion of correlation with cause. There is no doubt the recovery has gone wrong. Compared with forecasts as recently as February, the Bank of England now expects a persistently weaker recovery in the years ahead. If this permanent downgrading of our fortunes could be pinned to “plan A”, there would be a strong case indeed for a “plan B” of slower cuts and temporarily lower taxes.
In a world where fiscal consolidation is savaging demand, you would expect to see a spike in unemployment, inflationary pressures falling away and weakness in tax receipts. We see none of these in Britain today.
The latest labour market figures showed the largest fall in unemployment in a decade in the three months to April. Inflationary pressure is still rising with Michael Saunders of Citi pointing out that in May, the price of only 17 of 85 individual items in the consumer prices index rose below or at the target rate of 2 per cent – the lowest proportion of on-target inflation rates since 1997. Tax revenues continue to exceed expectations.
Instead, compared with the relative optimism of the autumn, the downgrade to economic prospects can be explained by a rise in energy prices and by continued poor productivity performance.
With oil prices 60 per cent higher than a year ago, an employee can buy less for every hour worked. Being poorer than we hoped is the cause of the £46bn additional borrowing forecast by the Office for Budget Responsibility, since society rightly seeks to mitigate the pain for some of the needy.
And yet, hard as it is, it is no use crying over spilt milk. Loosening monetary or fiscal policy as a response cannot change the price of oil, nor make people richer. The only response to a global price shock is for Britain to become more productive. Unfortunately, productivity has been the most disappointing aspect of the recovery so far. Where Britain used to be able to rely on productivity growth of roughly 2 per cent a year, it now counts any rise as a hopeful sign.
Unless productivity growth returns to its old stable habits, the “plan B” we will soon be talking about will be deeper and further spending cuts, because economic growth will fall short of targets year after year, rather than easing the pain of consolidation.
Surely, people say, the outlook would at least be better in 2011-12 if the coalition slowed the pace of the cuts a little – to those proposed by Alistair Darling in the 2010 Budget? Then consolidation would still happen, but there would be more room to breathe.
Perhaps. But it is easy to exaggerate the effect of a reversal to Labour’s proposed path of cuts. This financial year, the former government was proposing spending cuts £2.5bn smaller than George Osborne’s, accounting for less than a fifth of 1 per cent of national income. The effect on the economy would be smaller still.
The evidence, then, points to a rather gloomy prognosis. Instead of cuts curtailing growth, we see poor productivity derailing the prospects for expansion. Instead of deficit reduction squeezing the life from the economy, the pain has come from rising commodity prices over which Britain has no control. Instead of demand falling short, we see supply shocks that have cut output and kept inflation high.
It would be wonderful if slower deficit reduction could address the problems Britain has encountered in this recovery. But the economy is not facing a sudden crisis of confidence similar to 2008, when household and company spending suddenly stopped and macroeconomic policy was the right tool to prevent a slump. The economy faces a hangover from the hubristic years of the past decade and must adapt.
Talk of “plan B” increasingly sounds irrelevant – it is favoured by those who are unwilling to face up to the true problems facing Britain’s economy today.
The writer is the FT’s Economics Editor