Between a rock and a hard place
This piece by CentreForum’s Director, Julian Astle, appeared today on the Guardian’s Comment is Free:
The debate about how to deal with Britain’s mounting debts has been re-ignited by yesterday’s borrowing and growth forecasts from the Office of Budget Responsibility. Keynesian economists are warning of danger ahead. Their concern – that the coalition, in its determination to get on with the job of cutting spending and reducing borrowing, is putting the UK’s fragile recovery at risk – should not be lightly dismissed. Growth is weak and the risk of a slow down, or even a return to recession, is real. A return to negative growth would not only hit businesses and households directly, but, by shrinking the revenue base, could also wipe out many of the fiscal gains the government’s tax increases and spending cuts are designed to deliver. The government has every reason to take this threat seriously.
Now I don’t know George Osborne, but I have no reason to believe that he is either ignorant of, or complacent about, the potential negative impact of spending cuts and tax rises on economic output. This is a man whose time as Shadow Chancellor coincided with an increase in government spending from 38 to almost 50 per cent of GDP. It strikes me as pretty far fetched to claim, as some have done, that that he is either unaware of, or unconcerned by, the likely consequences of his fiscal decisions on growth.
A more plausible explanation for the government’s decision to sail closer to this ‘rock’ than some think wise, is that it is seeking also to avoid the ‘hard place’ towards which these self same critics would have them steer: a sovereign debt crisis. It is true that the UK is not Greece, and mercifully isn’t constrained by membership of the Euro, but the possibility of investors suddenly losing confidence in UK gilts cannot be discounted. When the G20 warned recently that “those countries with serious fiscal challenges need to accelerate the pace of consolidation”, it did so for a reason. There may be dangers associated with cutting spending too much too soon, but these need to weighed against the dangers of cutting too little too late. It is this course – between two clear and present dangers – that the coalition is seeking to navigate.
It is important also to distinguish between the cyclical and structural parts of the deficit. The coalition’s intention is to make a start in cutting the structural deficit – that part which will remain even after the economy has recovered. It is right to do so. Structural problems take years to solve, and, regardless of how the economy behaves, it makes sense to tackle them and to start doing so now. As for the risks of a weakening economy, a better approach is to have in preparation quick, reversible, tax-focused interventions that could boost demand without affecting the bigger structural job of work on which the government is about to embark.
Ultimately, however, fiscal policy is likely to have only a limited impact on the immediate economic outlook – the sums of money involved (£6 billion) are just too small. The same cannot be said of the government’s £200 billion Quantitative Easing programme. As CentreForum has argued in the past, if the government wants to stimulate demand while it deals with the deficit, it might be better advised to look for ways of redirecting some of this money to the households and businesses for whom the ‘credit crunch’ remains a day-to-day problem.