Monday, 6 July 2009

Tories risk economic calamity

Two pieces caught my eye over the weekend. Both deal with the gnarled topic of government borrowing and debt. I covered this issue a few weeks ago when discussing the project initiated by President Sarkozy to re-think debt chaired by Amartya Sen and Joseph Stiglitz. Some debt is good as it raises the productive potential of the economy.

Of course politicians are engaged in a semi-bogus debate about cutting public expenditure. The issue is not who is tougher. It is when the necessary fiscal stiffening should be initiated.Economically, we are most definitely not out of the woods yet. Both the supply of capital and the demand for capital appear to be declining. If the investment is not undertaken then that harms growth, employment, etc. What can fill the gap? Well, it's public expenditure or nothing. The latter is terrifying and that is why I find the Tories' line on debt and fiscal rectitude so concerning. They may be in government in a year. Watch the double dip recession- or worse- become a real possibility.

By focusing the debate on the level of debt, they have made short-term political capital but they are creating a irresponsible dialogue. The major issues facing the economy currently are the continuing risk of financial collapse and the associated decline in demand. Richard Koo, through his experience of the Japanese economy which has sustained a series of shocks over a decade and a half, cautions us not to become too cautious when it comes to debt. I would be encouraged if all front line politicians read his book as a matter of urgency. Will Hutton picked up his arguments in his Observer column yesterday (I will say it again, Hutton has become a must-read commentator once more.)

The debate that has been going on about debt and cutting spending simply ignores thefundamentals- the British economy is facing serious structural weakness and we still don't know how that is going to pan out. Debate about what the spending and capital expenditure will be in 2013 are, frankly, irrelevant. All we can say is that when the economy shows signs of sustained recovery and growth, the stimulus can be withdrawn and we can return to normal times again. We do not know when that will be. If we try to return to orthodox economics too early then we could face calamity. That is the more powerful argument against the Tories' approach to the economy.

They are facing exactly these challenges in the USA. Krugman, Stiglitz (yes, him again), Nicholas Nassim Taleb appear to have vindicated. Vice President Joe Biden in a characteristic display of honesty admitted that the administration may have underestimated the scale of the economic malaise. In terms of the urgency of the stimulus and the required magnitude it may have undershot. The aforementioned economists and commentators argued this at the time. They won't be coy in coming forward with a brutal 'I told you so.'

Congressional Republicans are quickly assuming an attack formation. But their assertion that the economy will self-correct is taken from the playbook of depressions past. They seem to want to play the Herbert Hoover card with a Panglossian flourish.

Thank goodness for the world economy that they are not in control of either the executive or legislative branches. Nor will they be until at least November 2010. The risk that their political bed-fellows in UK will come into office earlier is greater. What the Tories may do to public services seems to be a relatively blunt political attack. What they may do to the economy is far more scary and potent.

The problem with this is that it requires a degree of honesty about the risks facing the economy even if we start to see more convincing green shoots. Labour's strategy seems to be to demonstrate that it turned the economy round. And the right moves have been played. However, why de-prioritise the economy when it remains the most important issue facing us for the foreseeable future? Instead, the better way to force the Tories onto the defensive- rightly- is to say that weaknesses persist, risk abounds, and the last thing we need is to drag the economy back into the mire through naivety and ideology. A head-strong ideologue is the last thing Britain needs and David Cameron has that air.

One final thing. To do what needs to be done the tennis loving Governor of the Bank of England, Mervyn King may well have to be taken on. He is continually parroting the Tory line on debt. Nobody wants high levels of debt and we must display to international markets that there is a grip on public expenditure and that borrowing is a crucial component of returning the economy to growth. However, if the economy rocks and jerks any more then debt may be a lesser of two evils. That was certainly the Japanese experience (as Tim Geithner the US Treasury Secretary knows only too well.) Why are we incapable of even peering back at recent history?

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