Don’t fall for the growth confidence trick

Revised growth figures for the final quarter of last year show Britain’s economy was, at best, flat. Given this, there is a good case for delaying planned fiscal consolidation over the next year or two in the forthcoming Budget. Indeed, one much-cited argument against doing so – that any change in the current plan would damage confidence in the economy – is fundamentally flawed.

Latest figures show that while UK manufacturing and exports are strong, consumer confidence is weakening. Most of the government’s fiscal changes are also yet to kick in, with big cuts to spending, tax rises and welfare benefits scheduled for April. Given this economic weakness, and the large amount of spare capacity in the economy, stretching out the fiscal consolidation by scaling back spending cuts seems reasonable.

To date, the government’s riposte to arguments for a delay has been that if we do not follow the original plan to the letter, businesses, households or financial markets will lose confidence in the government’s economic strategy. George Osborne, the chancellor, again last week painted a picture of panic in the markets, credit rating downgrades and “Britain next in line behind Ireland and Greece”. Even the Institute for Fiscal Studies has said fiscal loosening “risks undermining investor confidence”.

This is not a justification, economic or otherwise, for the policy. Instead it is an argument for never changing policy at all. It is an especially odd position for the IFS to take because it is in no sense based on economics. Instead it relies on an odd view of market psychology, one that says markets have more confidence in governments that never adjust policy, even when it is sensible, from an economic perspective, to change course.

This is not plausible. Markets can, of course, be irrational. But there is neither a theoretical reason nor any empirical evidence to suggest that they are irrational in this particular way. Indeed, history suggests the opposite: that the real hit to credibility comes from sticking to unsustainable policies – think Argentina in 2001 or Britain in 1992.

How would markets respond to a delay in fiscal consolidation? With borrowing cheap, debt default risks very low and a significant output gap there is essentially no evidence to believe that a short-term loosening would lead to markets losing confidence in the UK’s ability to service its debts. To suggest otherwise – to liken the UK to Greece – is scaremongering. Indeed, some loosening, particularly if offset by a sensible adjustment to medium-term plans, could actually boost both growth and employment without any significant cost to inflation or longer-term fiscal sustainability.

If Mr Osborne really does want a “Budget for growth”, he should amend his plans. Measures to boost employment prospects of young people would be a good start. Almost 1m young people are not in work, education or training; action to help them find jobs could boost demand and reduce future costs. The misguided scrapping of educational maintenance allowances should also be reversed. Independent evaluation showed this helped young people stay in education, and paid for itself over the longer term. Both measures would create more demand in the short term, while improving productive potential in the future.

If the government is serious about promoting growth, it should also look again at its plans to cut skilled migration and restrict student visas. The Treasury’s own analysis suggests that the proposed limits will reduce growth significantly over the next few years; while higher education is a successful, dynamic British export industry. Current plans will inhibit the recovery and worsen our fiscal position.

Of course, the case for these policies, as opposed to other priorities, needs to be made on their merits. But there is no reason, theoretical or empirical, why sticking to the current fiscal consolidation plan, if circumstances change, should be better for confidence. In fact, there are plenty of reasons why it will probably make things worse. If Mr Osborne really wants to inspire confidence, he should think again.

The writer is director of the National Institute of Economic and Social Research

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