Sunday, April 28, 2013
A little growth takes a lot of pressure off Osborne
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.

0.3 is a very small number, but in recent days it has been hugely significant for George Osborne. It featured, most obviously, in the first quarter gross domestic product figures, the 0.3% rise breaking the hearts of the chancellorís critics and allowing him to claim the economy is healing. That may be premature; the recent pattern means further quarterly GDP declines cannot be ruled out.

But as small mercies go, this was welcome and should lead to upward revisions of 2013 growth forecasts. The consensus was for 0.1% and the Office for National Statistics has a penchant for nasty surprises.

The other 0.3 relates to public borrowing: the deficit. Since December, when the Office for Budget Responsibility (OBR) endorsed the Treasury view that borrowing in 2012-13 would be down on 2011-12 (against the run of the numbers), the worry was that this would turn out wrong.

In last monthís budget, even after strenuous efforts by Treasury ministers and officials, the OBR concluded the margin would be wafer-thin, just £0.1bn. It was indeed wafer-thin, but £0.3bn - borrowing fell from £120.9bn to £120.6bn - and as the OBR pointed out, initial figures have tended to be revised lower in recent years.

Growth, of course, is still weak, and borrowing very high; about £30 billion higher in 2012-13 than officially predicted at the time of Osborneís first budget in June 2010. Public sector net debt is rising and at the end of March was £1,186bn, 75.4% of GDP.

So whatís changed? Well, the heat has been taken out the International Monetary Fundís visit to Britain next month. A GDP fall would have lent weight to the call by Olivier Blanchard, its chief economist, for Britain to relax austerity.

That was never going to happen. Osborne told the IMF he would continue with his medium-term deficit reduction plan. The IMFís own research, showing so-called fiscal multipliers are very small in Britain - tax hikes and spending cuts do less harm than elsewhere - made its chief economistís advice look odd.

If too much austerity is doing damage it is in the eurozone, where latest German surveys were weak and Spanish unemployment has hit 27.2%. But the IMF declared eurozone fiscal policy broadly appropriate.

IMF fireworks have been avoided, as probably have fireworks at the forthcoming monetary policy committee meeting on May 9. The MPC will probably refrain from further quantititative easing, particularly with the extension of the Funding for Lending scheme until 2015. This does not rule out action when the new governor, Mark Carney, arrives, though he is playing down expectations.

The great virtue of the GDP figure, however, was it should allow a sense of perspective to be restored. Anybody listening to the debate over the past week might conclude that the case for austerity had evaporated as a result of errors and omissions in research by two American economists, Carmen Reinhart and Ken Rogoff.

Reinhart and Rogoff, famous for their book This Time is Different, on financial crises, published research three years ago showing government debt above 90% of GDP is associated with slower growth.

That is still their finding, as they are at pains to point out. One always implausible result - debt levels above 90% are associated with negative growth of 0.1% - has been rightly removed from the record by the discovery by University of Massachusetts economists of the error. But the big picture, growth around a percentage point a year slower at high debt levels, remains.

There are two essential points on this. The first is that many studies have shown high debt is associated with slow growth. A 2011 Bank for International Settlements (BIS) paper by Stephen Cecchetti and others, concluded: ďOur results support the view that, beyond a certain level, debt is a drag on growth. For government debt, the threshold is around 85% of GDP.Ē

The IMF said in this monthís World Economic Outlook high debt overhangs lead to lower public and private investment and reduce room for manoeuvre. Other IMF studies found a 10% rise in the debt ratio associated with a growth reduction of 0.2%, while a 2011 study found significant negative growth effects with debt above 70%.

Of course there is nothing magical about 70%, 85% or 90%. Circumstances matter. When Britain ran debt of over 250% of GDP at the end of the Second World War it necessitated austerity but there was also a route out. The economy would return to peacetime spending, as war operations were run down. Debt to GDP halved in a decade.

It is different, however, when - as the Institute for Fiscal Studies pointed out in its green budget - without action to rein back the deficit - public sector debt would have been on a trajectory that would have taken it back up to 250% of GDP.

So we should step back from the often vicious debate among American economists. The case for austerity was never based on one paper, or mainly on the growth consequences of high debt.

It was about trying to stabilise an appalling deterioration in the public finances: a record peacetime budget deficit, a huge structural deficit and rocketing government debt and interest payments. It was about trying to avert a fiscal crisis.

That was why Labour proposed a Fiscal Responsibility Act with debt falling as a percentage of GDP by 2016, and why the coalition aimed, though will not achieve, an earlier fall. The sustainability of the public finances meant not letting debt rip.

What if the cure is worse than the disease? For austerity critics, the direction of causation is from growth to debt. In other words, if austerity had been less, growth would have been stronger.

That may be true in the short-term, though in Britain growth would have been weak even in the absence of austerity because of the credit crunch, falling real incomes and the eurozone crisis. Growth might have been slightly better at most but debt would have risen more.

In the long run, growth depends on the supply-side, not short-term fiscal or monetary activism. Look at high debt/slow growth economies like Italy and Japan. Japanís current burst of expansionary policy will not change this. It is a slow-growth model Britain has to avoid.