Sunday, September 11, 2011
How to build a stronger recovery
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Gloom with a capital G. What should we do about it? George Osborne, in a speech, signalled the inevitable: a downward revision of official growth forecasts come November.

The Organisation for Economic Co-operation and Development (OECD), said that the economic recovery has “come close to a halt” in the industrialised countries and appears to be moderating even in strongly-growing emerging economies.

The OECD expects only 0.1% growth in Britain in each of the third and fourth quarters, stagnation in other words. Germany and the eurozone big three (Germany along with France and Italy) will see negative growth in the final quarter, it says.

That loss of momentum was evident in the three purchasing managers’ surveys for August, which suggested manufacturing is shrinking and construction and services slowing, the latter at its sharpest rate for 10 years. Chris Williamson of Markit said the three surveys together pointed to “near-stagnation” last month.

There are caveats. The OECD’s forecasting record is not that great and its numbers carry large margins of error, even for what will happen over the remaining months of the year. The gloom on Germany, indeed on industrial prospects in general, was tempered by the announcement of a 4% rise in output in July alone.

The purchasing managers’ surveys are very useful but not always well-correlated with official data. A month ago we were taken aback by its strength. Its latest weakness had a bit to do with the August riots.

It would be ridiculous to argue, however, there is no slowdown, not just in Britain but across the advanced world. Japan has shrunk for three quarters in a row, not helped by the earthquake and tsunami. Economists are starting to predict a double-dip for America.

The Bank of England decided against relaunching QE at its meeting on Thursday, rightly in my view, deciding to hold fire on more quantitative easing. But it is firmly back on the agenda and, while we do not agree on everything, hats off to Danny Blanchflower, formerly of the monetary policy committee (MPC), for saying it would do so before any interest rate hike.

There is a pressing need for more bank lending to small and medium-sized firms. There may be no surprises in tomorrow’s Indepependent Commission on Banking report but its self-imposed remit, that nothing it does should hamper the supply of credit, is unlikely to be achieved.

So what can be done? The political knockabout between chancellor and shadow chancellor does not get us anywhere. Osborne insists he will stick to his deficit-cutting strategy, while Ed Balls calls for a temporary cut in Vat he knows would leave that strategy in tatters.

Let me offer some assistance. When Osborne set out his spending plans nearly a year ago, in one important respect he stuck to what he inherited from Alistair Darling, his newly-controversial predecessor. He stuck broadly to Labour’s plans for slashing public sector capital spending, on roads, bridges, hospitals, schools and the rest.

Even under tough coalition plans, current spending on public services, including wages and salaries, will rise throughout this parliament, from £600.9 billion in 2009-10 to £713.4 billion by 2015-16.

Capital spending, by contrast, is being butchered. Gross spending will drop from £68.9 billion in 2009-10 to a low of £47.7 billion in 2013-14, before creeping up to £50.4 billion by 2015-16. Spending net of depreciation will fall from £49.5 billion in 2009-10 to £23.8 billion in 2013-14 and will only be £24.5 billion - half its earlier peak - in 2015-16. Remember these are cash sums, so the drop in real terms is even greater.

Cutting capital spending like this is a bad idea. Fiscal multipliers, the amount of economic bang a government gets for its spending buck, are always significantly higher for capital spending.

Spending on projects boosts employment and helps the economy more generally. The Office for Budget Responsibility’s (OBR) fiscal multipliers are three times higher for capital spending than for a Vat cut, further calling into question the Balls’ argument. Official calculations in Washington suggest even larger multipliers for capital spending.

A report from the CBI and KPMG on Friday called for “swift investment across Britain’s road and rail networks, digital, waste and energy” to ensure Britain remained internationally competitive and to kick-start growth. It was accompanied by a survey of 447 firms which showed that 58% rated Britain’s infrastructure as worse than other EU countries.

But how to provide such a boost? After all, as Labour’s chief secretary said on leaving office, there is no money left. The clue is in the numbers. Current spending is rising, capital spending falling sharply. Shift a bit between the two and you have a growth-stimulating infrastructure boost.

Some of this could be done painlessly. Gilt yields have fallen sharply in the past few months, whether reflecting Osborne’s “safe haven” or weaker growth prospects. If maintained then, using the OBR’s ready reckoner, that will cut the government’s debt interest bill significantly, by more than £6 billion in 2014-15 and over £7.5 billion in 2015-16.

I would go rather further. Departments under the spending cosh will no doubt say every penny of current spending is precious. I would be surprised if a few billion, over and above debt interest, could not be squeezed out and diverted to capital projects. At minimum, it should be possible to raise the gross capital spending by government by £10-15 billion, with all the benefits that would bring, but without compromising the coalition’s fiscal strategy.

So there we are. A plan for some good old-fashioned recovery-boosting spending on public works. It does not involve increasing the overall spending totals. It does not involve unrealistic ideas about borrowing more, when the government is already borrowed up to the gills. It is infinitely better than temporary Vat cuts. I commend it to the House.