David Cameron and George Osborne are learning the wrong lesson from Gordon Brown’s time in office. Rather than demonstrating the power of their economic ideas with deeds at home, Britain’s prime minister and chancellor are now following Labour’s previous prime minister in preferring to lecture others abroad. The reaction at the World Economic Forum last week was unappreciative.
Instead of counterproductive posturing, ministers should recognise that the area in which Britain still leads the international debate is fiscal policy. Over the past four years, under both Mr Brown’s Labour government and Mr Cameron’s coalition government, the UK was early to understand the situation and rapid in its response.
The Labour government recognised the sudden stop in private sector spending in late 2008 and implemented a fast and temporary fiscal stimulus. By mid-2009 most of the rest of the advanced world had followed. Labour also saw the need for subsequent fiscal repair and started to tighten fiscal policy at the start of 2010, a shift subsequently deepened and defined fully by the new government later that year.
None of Britain’s fiscal tightening has been forced by market panic or credit downgrades. It is policymaking and delivery that generates genuine admiration around the world.
For all the success so far in articulating how public deficits will decline, no one should doubt the scale of the task to come. The International Monetary Fund expects public sector borrowing still to be 7.8 per cent of national income in 2012: only the US and Japan are likely to borrow more. By the end of March, three-quarters of the tax increases planned will have been implemented, but only 6 per cent of current spending on public services will have taken place. Much can go wrong, so it is not surprising that many are angry with deficit reduction.
Complaints are loudest at home. It is striking, however, that the most vocal arguments for fiscal loosening range from the mad to the bad.
The current leadership of the Labour party runs the most absurd arguments of all. Weaker economic forecasts, which have reduced the expected path of deficit reduction, stem from higher commodity prices, the confidence-sapping effects of the eurozone sovereign debt crisis and last summer’s wrangles over the US debt ceiling.
To argue, as Labour does, that austerity measures have caused the economic disappointments is nonsense. It could be true only if Britain’s rise in value added tax had contributed to the Arab spring and the rise in the oil price, or if cuts in the budget of Bromley Council had some bearing on the solvency of Greece. The independent Institute for Fiscal Studies was kind on Wednesday when it described such arguments as “implausible”.
Bad arguments for loosening austerity generally refer to the gilts market – where yields on 10-year UK government bonds stand close to record low levels at just above 2 per cent. These low yields show that the government deficit reduction plans have credibility, and that current expectations of future growth and interest rates are low. What they do not show is that the government could go on a borrowing spree today without those yields reacting. The one thing we have learnt from financial markets over recent years is that only fools take market prices as a cast-iron indication of fundamental value. Market prices told us little about the true value of subprime mortgage debt or Greek sovereign debt until it was too late.
When it comes to changing the planned path of deficit reduction it is wise to be open to the need to change your mind. If there are circumstances in which fear again rises to post-Lehman levels, so only the government can be the borrower of last resort, it should be willing to act. The case for fiscal loosening also rises if evidence builds that monetary policy is completely impotent in driving demand.
But Britain is still some way from suffering these conditions. It is in the middle of another nasty jolt in a slow and grinding recovery. The main disease was overconfidence about Britain’s economic strength before the crisis. Public austerity is the only long-term cure.
The good news is that the latest burst of data on business activity has been positive – all the more reason for avoiding another temporary fiscal stimulus now. It should not be a tool for all seasons.