George Osborne is fond of martial metaphors. In his Mansion House speech in June, the Chancellor quoted Winston Churchill in support of his deficit reduction plan: “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” But at 0.2 per cent, growth in the second quarter has once again cast doubt on Mr Osborne’s boast that his strategy is working. A quote from Tacitus would have been better: “They made a wasteland and called it peace.”
The reason the current strategy will fail was succinctly stated by John Maynard Keynes. Growth depends on aggregate demand. If you reduce aggregate demand, you reduce growth. This is what is happening.
When he assumed office in May 2010, the Chancellor claimed Britain’s government faced a loss of investor confidence that demanded fiscal retrenchment The initial reaction to his emergency Budget of June 2010 was favourable: on the markets gilt yields fell and Mr Osborne basked in the approval of the International Monetary Fund.
Yet these two crucial pillars of support for the coalition’s policy look shaky. First, the international technocrats now seem much less certain that the Chancellor is leading us out of recession. In its latest and most sophisticated study of fiscal austerity, the IMF concluded that it did have “contractionary effects on private domestic demand and GDP”.
This should hardly come as a surprise: IMF studies from 2009 and 2010 found the same. Potentially much more destructive, however, investors are also beginning to change their tune.
In the early days of the eurozone sovereign debt crisis the markets did indeed identify fiscal profligacy as the problem. Investors demanded an austerity plan in Greece, and were delivered one in May 2010. The results have disappointed, however – with the continued shrinkage of the Greek economy leading to missed fiscal targets, despite aggressive cuts. Last month, the original bail-out programme had to be extended, as investors continued to flee Greek bonds.
When, in July, the crisis spread to Italy, many analysts were puzzled. Why should the only eurozone country scheduled to run a primary fiscal surplus in 2011 be under attack? The message from the bond markets is clear: investors have begun to realise that austerity alone is proving a false trail. The royal road to creditworthiness runs not via cuts alone, but via growth.
These recent bond market developments should worry the Chancellor. His one-dimensional focus on austerity was once the government’s greatest asset. It is fast becoming its major liability. Fortunately, he already has the tools he needs to change course.
As we have argued, a scaling-up of the government’s new Green Investment Bank – to become a full-scale National Investment Bank – can play a major role. Keynes advocated digging holes and filling them up again if the government could think of nothing better to do. But the coalition has already identified a more useful range of investments – like halving carbon emissions from 1990 levels by 2025.
The obstacle so far has been funding: the Treasury has provided the Green Investment Bank with only £3bn ($4.93bn) of capital and will not allow it to borrow. Yet here too the coalition is already close to a solution. Nick Clegg, deputy prime minister, recently began a debate over how to dispose of the government’s shareholdings in the UK’s bailed-out banks. Yet rather than his plan to distribute shares to voters, the government should use the proceeds of selling its stock to capitalise a full national investment bank.
This would be neutral for public debt and require no new deficit spending. With (say) £10bn and the power to borrow, the enlarged bank could begin to mobilise frozen private savings to offset the effects of fiscal contraction, while also preparing the economy for a greener future. This would not be a Plan B or even Plan C. Instead it would be Plan A+, to which all sides ought to be able to agree.
The writers are author of ‘Keynes: The Return of the Master’, and an economist at Thames River Capital LLP, a London-based asset manager