Wednesday, 16 September 2009

Election is about judgement not cuts

I've mentioned Richard C Koo's The Holy Grail of Macro-Economics before and, given that I'm in Tokyo at present, what better time to re-read. I'm glad I did as it gave me the inspiration for my LabourList column this week: This election is not about cuts- it's about judgement.

This whole argument about 'cuts' has been really niggling me for the last couple of weeks. It is slightly disappointing to see the Government get sucked into it, as allowing it to be the definitive discussion risks economic insanity. The Prime Minister knows this of course. But Labour must take charge of issues and on this one- despite being in the right- it has failed to do so.

The simple fact is that the Japanese government, facing what Koo calls 'a balance sheet recession' characterised by a major decline in demand for debt following the bursting of an asset-price bubble, took their foot off the gas too early on two occasions: in 1997 and 2001. The result was disastrous both times- economic growth plummeted, tax revenues collapsed, and rather than shrinking, deficits increased. This is what the Conservatives risk with their economic policy.

Alastair Darling has said that the deficit must be cut in half within four years of the resumption of growth. Ideally, sure. But no-one knows how the economy, tax revenues etc will fare in the recovery phase. Actually, Japan's experience shows that as corporate balance sheets are purged tax revenues can actually soar. But we just don't know. What we do know is that an early return to fiscal rectitude could be disastrous. As Koo puts it, in this scenario governments should 'err on the side of incaution.'

Don't get me wrong, I'm not arguing that we should not be concerned about the deficit and national debt. But they are a necessary evil in these abnormal economic times. If we cut as if we are in normal times then that will be calamitous. Deficits can be a good thing if they prevent the economy tanking, are not inflationary, do not crowd out private sector investment, and invest to raise the productive potential of the economy, i.e. future incomes and consequently tax revenues.

That is exactly the set of circumstances we are now in. So the question, in a country whose national debt is not particularly high in comparison with similar advanced industrial economies, is not can we afford the deficit? The question is can we afford, in current circumstances, to be without it?

Finally, on the history of cuts, there hasn't been a single year (apart from 1946) when public expenditure actually declined. You can look at this great website UK Public Spending (run by a US conservative it seems but that makes it even better!) to compare. Here is the year by year expenditure from 1940:

And here is the national debt, which interestingly doesn't dip beneath 100% of GDP until the early 1960s:

The key point here is that public expenditure does not have to be collapsed in a deficit scenario, it has to be managed. It will take quite a while to pay down the current national debt but while interest rates remain low there is no need to panic. Keeping the economy on track is the best means of repaying the debt, and that must be the absolute focus. And please Labour, stop playing the Tories' game.

My column concludes:
So all this talk of cuts - and it is disappointing to see the Government start to get sucked into it - is grossly premature. It is highly dangerous. Nobody knows how quickly the fiscal situation could recover as we are in unchartered waters. There are signs that tax revenues increase very rapidly following a situation like this one but that’s an optimistic scenario. But damage this recovery and we know they will worsen significantly as will the deficit.

Should the Conservatives secure an election victory that they crave but do not deserve, they will face a stark choice just as the Hashimoto and Koizumi administrations did. Either the economy or policy is jettisoned. Should George Osborne become Chancellor then I have a prediction. By his second Budget he will be in the midst of a panicked reversal of his Government’s economic policy.

That is the public discussion that Labour must provoke over the next few months. It should ignore siren voices and make the case - whatever the short-term data shows - that this recovery is far form certain.

Talk of ‘cuts’ is a fine hypothetical discussion but it’s not the primary issue. The real choice is between judgement and recklessness. It is this Prime Minister and this Government who have demonstrated that judgement.

1 comment:

  1. Hi Anthony - interesting article. Shall I assume that you prefer comments at Labour List, where it is busier? I'll do that.