Sunday, September 12, 2010
No alternative to spending cuts
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

carving.jpg

My regular column is available to subscribers on www.thesundaytimes.co.uk - this is an excerpt.

For months a debate has been raging. In February, 20 top economists, led by former monetary policy committee (MPC) member Tim Besley, wrote to this newspaper pointing out that Britain had entered the recession with a large structural budget deficit, needed a credible plan to reduce it, and in doing so would make sustained economic recovery more likely.

Even before the ink was dry on the Sunday Times 20 letter, however, there was a riposte, led by the Keynes biographer Lord Skidelsky and Danny Blanchflower, another former MPC member. The "Financial Times 60" had three times the number of signatories, and argued that aggressive cuts were economically barbaric and would pull the rug from under the recovery.

So it has gone on, cutters versus spenders. The spenders have probably had more names, suggesting economists are still mainly Keynesian (letter-writing ones at least) and they have a political champion in Ed Balls, former education secretary and Gordon Brown's economic guru.

He has written to Danny Alexander, Treasury chief secretary, arguing there was "an economically credible alternative" to cuts, drawing on his speech at Bloomberg, the financial news service, on August 27.

Balls's Bloomberg speech has been widely praised. For me, the surprising thing it revealed was how somebody who was at the centre of Britain's economic policy for so long is either ignorant of economic history or determined to rewrite it.

He has a dodgy view about 1931 and even more about 1981, when 364 economists famously wrote to The Times to attack Sir Geoffrey Howe's March budget. They were ignored and, according to Balls, the consequences included "the deepest recession since the second world war". I thought every schoolboy knew the point about that letter was that it coincided exactly with the start of the long recovery of the 1980s, which is why it gave such communications a bad name. Balls was a schoolboy at the time, but that's no excuse.

As for recent history, Balls's claim of "no significant structural deficit . . . until the collapse of tax revenues from the City of London in 2008" would be challenged by every serious fiscal commentator. The structural deficit, according to the Office for Budget Responsibility (OBR), averaged 2.7% of gross domestic product (40 billion in today's prices) from 2003 onwards.

That is looking back. What about looking forward? Is the government's approach to spending "economically misguided and dangerous", as Balls suggests?

The parameters are that the coalition inherited from Labour 73 billion of fiscal tightening by 2014-15, 52 billion of it through reducing planned public spending. It added a further 40 billion of tightening, 32 billion through spending, in George Osborne's June 22 budget. We have had the details on tax but are awaiting them on spending.

There was an argument that Alistair Darling's 73 billion, which would have halved the deficit over four years, was enough. The public finances are improving faster than the Treasury predicted. The problem was that Labour ducked holding a comprehensive spending review.

The coalition went further, deciding it had to reassure the markets, and it set itself a goal of eliminating the structural current deficit by the end of the parliament.

There is plenty to criticise about having a political timetable for deficit reduction rather than an economic one. The coalition overdid the comparisons with Greece. There will some very bad decisions, as well as good ones, on October 20. But the minimum the new government could have done was implement Darling's plans, which would not have offered much additional reassurance. Osborne went for what was probably the maximum.

There was no case, however, for doing nothing. Balls, as he made clear in his speech, would not have gone as far as Darling, warning him that "trying to halve the deficit in four years was a mistake". It is not clear he would have done anything and it is not hard to imagine the consequences. If you wanted to conjure up a post-election fiscal nightmare it would have been a minority Brown government with Balls as chancellor. The AAA rating would have gone quicker than you can say Maynard Keynes.

It surprises me that commentators who back Balls's argument that there is no crisis in the public finances, as shown by low gilt yields, ignore the fact that those yields reflect, at least in part, the big fiscal tightening that has been announced.

One of the papers presented at the Jackson Hole monetary conference last month made the point that governments can only get away with big borrowing if markets are convinced it is temporary, in other words if there is fiscal credibility. Labour lost that credibility and the coalition is trying to get it back. The appointment of the Institute for Fiscal Studies' Robert Chote as head of the OBR will help.

Why not ignore the markets and ratings agencies and carry on borrowing, rather than sacrifice public services and government projects? To do so would, according to the IFS, leave the deficit at 7% of GDP at the end of the parliament and put Britain's public debt on an unsustainable path to 100% of GDP and well beyond.

What about the risk that with all countries tightening together, the recovery will peter out? It is hard to see much tightening in America if anything, the opposite.

The Organisation for Economic Co-operation and Development, which last week said the upturn in advanced economies was slowing, acknowledged the case for countries that had "fiscal space" to slow the pace of their tightening. By that, however, it meant countries such as Germany, with budget deficits of less than 4% of GDP, not Britain, which started with an 11% deficit, one of the highest in the OECD. The legacy Balls helped create was one where Britain had no fiscal rules and had run out of fiscal space. There really is no alternative to significant spending cuts in Britain.