Industry | 2009.12.02
A deficit of patience | Larry Elliott
Cameron isn\'t all wrong about Britain\'s finances. But to slash spending now would be madness
David Cameron is having a mad monetarist moment. That\'s the only conclusion to be drawn from his insistence that the first task of a Conservative government will be to start cutting Britain\'s budget deficit. What we need, he told the CBI this week, is a decisive plan that starts now.
This sounds strong. It sounds purposeful. And it has an appeal on the doorsteps. After all, if individuals are paying down debts, doesn\'t it make sense for the government to be doing so? Actually, no. The alternative to state spending would be weaker overall demand and an even more painful recession. What Cameron is suggesting is dangerous and economically illiterate.
Here\'s the state of play. The UK economy did a little less badly than previously thought in the third quarter of 2009, with output shrinking by 0.3% rather than the estimated 0.4%. That still means the recession has lasted for six quarters,is the longest since modern records began in 1955. Moreover, Britain has a zombie banking system, kept alive by periodic injections of cash from the Bank of England but seemingly incapable of getting money to struggling businesses – where it is most needed. Conclusion? Blofeld got it right in You Only Live Twice when he told James Bond that this is "a sick nation by any standards".
Cameron says immediate action on cutting the deficit would keep Britain\'s creditors sweet and prevent "crowding out", the notion that high government borrowing pushes up long-term borrowing costs and makes private sector investment less attractive. His template is Geoffrey Howe \'s 1981 budget, which took action to reduce the deficit when the economy was only emerging from a deep slump and was – according to Conservative folklore – the catalyst for the growth that followed.
Policy Exchange, a right-of-centre thinktank, goes further. It has studied 12 cases of spending cuts, both from the UK and internationally, and concludes that getting to grips with the public finances has been good for growth. For example the National Government slashed spending from 1931 to 1934, but growth averaged 3.3% in following years.
This, though, is a perverse reading of history. The reason the UK grew after 1931 was that sterling was the first currency to come off the gold standard, and took advantage of a big devaluation to cut interest rates to 2% by early 1932, where they remained virtually unchanged for 19 years. Britain also threw tariff barriers around its colonial possessions; it was the combination of depreciation, cheap money and imperial preference that caused the recovery.
Similarly, the monetarist reading of the 1981 budget ignores the fact that the economy received a triple boost from a 30% depreciation in the pound, a slump in oil prices to below $10 a barrel, and lower interest rates. It was not deficit reduction that made lower borrowing costs possible; it was the fact that the Thatcher government\'s monetarist experiment had wiped out a sixth of UK industry and set unemployment on course to hit three million.
Cameron is right that Britain entered this recession with too high a deficit. He is right that the structural bit of the deficit needs to be tackled. He is right that the rebalancing of the economy towards manufacturing and exports requires a mixture of loose monetary policy and tight fiscal policy. But his experience as an adviser to Norman Lamont should have taught him the virtue of patience. In the spring of 1993, six months after the pound was bundled out of the ERM, the economy was showing signs of life, but Lamont decided against immediate action to reduce the deficit. Instead, he pre-announced changes to take effect in 1994, by which time the economy was strong enough to withstand them.
As Dominique-Strauss Kahn, the head of the IMF, noted this week, policy tightening should await a sustained recovery in private demand and entrenched financial stability. Britain has neither of those things. With the US looking fragile and European demand weak, there is the threat of a double-dip recession in 2010. What Cameron is proposing would turn that threat into a stone-cold certainty.
For more information, please visit
http://www.guardian.co.uk/commentisfree/[...]5/camerons-deficit-of-patience
