Sunday, January 10, 2016
Don't drink too deeply of Osborne's dangerous cocktail
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.

Such is George Osborne’s reputation for political cunning, the natural reaction to anything he does is to look for the true meaning behind the message. Prince Metternich’s observation on the death of Talleyrand – “What did he mean by that?” – springs to mind.

The chancellor is in good health but his warning three days ago, that Britain’s recovery faces “a dangerous cocktail of new threats”, provoked similar thoughts.

When, in November 2014, David Cameron talked of the “red warning lights … flashing on the dashboard of the global economy”, and was quickly backed up by Osborne, it was pretty obvious what they were up to. With the election less than six months away, they wanted to remind people not to risk handing over the economy back to Labour.

As I put it back then, the world was not about to go pop but they wanted voters to think it might, and that only they could be trusted to shield voters from the damage.

This time, some of the chancellor’s motivations are fairly clear. The government has faced criticism over cuts to flood defence spending, as Osborne did last year over his planned – and eventually abandoned – cuts to tax credits. Hence his emphasis on the work still to be done on the budget deficit.

There are two things to say about spending on flood defences. One is that given the scale of the rainfall in recent weeks, the overwhelming majority of the flooding problems we have seen would have occurred with or without the spending reductions of the coalition government’s early years. Spending was cut by 16.5% in real terms in 2011-12 and maintained at the new lower level (which was roughly what was being spent in 2007-8) for two more years.

But we are not talking about billions of pounds here – the 2011-12 cut was less than £100m in cash terms – and even some defences that were considered state of the art proved inadequate. If extreme weather events are becoming the norm, spending on flood defences by all recent governments has been significantly too low.

The second point is that the benefits of good flood defences and related infrastructure improvements far exceed the costs. The fact that those benefits may be intangible – when flooding does not occur it is a non-event – should not matter. Preventative medicine also brings large benefits. That rethink everybody is now talking about on flood defences is necessary. A government that goes on a lot about security must be aware of the insecurity of having your home or business flooded out, or being under threat of it.

But, and this was one of the aims of Osborne’s speech, the public finances are a long way from being fixed. Splashing out on flood defences, no pun intended, will require compensating cuts elsewhere if the chancellor still intends an eventual budget surplus. Six years after it peaked at more than £150bn, public sector borrowing is officially predicted to be more than £70bn this year, and there are pressures on that forecast after a couple of disappointing recent monthly figures.

Was Osborne responding to disappointing pre-Christmas growth figures and getting his retaliation in first ahead of a sharp slowdown this year? As I said at the time, previous experience suggests we should take the late-December data revisions from the Office for National Statistics with a pinch of salt. Most economists expect similar growth this year to last and they are not known for viewing the world through rose-coloured spectacles.

That said, a few things have changed for the worse in the past few weeks. There have been downward revisions to global growth forecasts, particularly for emerging market economies. The World Bank, for example, has just revised down its prediction of global growth this year from 3.3% to 2.9%, and for next year from 3.2% to 3.1%. Both would be better than last year’s estimated growth of 2.4%, which is important to bear in mind, but weaker than hoped.

The World Bank still thinks Chinese growth, at 6.7% this year after 6.9% last, will be with within touching distance of 7%. Investors who have been panicking about China’s prospects in recent days would be more than pleased with that.

It is hard to say whether the Chinese stock market panic reflects genuine concern about the country’s growth prospects or whether it is mainly a response to cackhanded interventions by the authorities. But it has ensured a dreadful start to the year for world markets, including our own FTSE-100, and it has been accompanied by a further plunge in the oil price to a 12-year low of under $35 a barrel.

That further fall in oil prices, when in the past an escalation of tension between Iran and Saudi Arabia might have been expected to push them higher, shows what a changed world we are in. Traders have decided that this oil glut is not going away, and that Iran-Saudi tension means co-operation within the Organisation of Petroleum Exporting Countries to make it do so is even less likely than it was.

So how worried should we be by these recent developments? The stock market’s grim start to the year is not good news but the correlation between what happens in the markets and the real economy is weak, and even more so in China than Britain.

The fall in oil prices is in danger of turning from a helpful boost to growth to a damaging rout which could set back energy investment for years. It looks as if we are now firmly in overshoot territory for oil prices, but without any indications of when prices might start to bounce. The predicted cold snap should help retailers still trying to offload winter clothing lines, and it could help the oil price.

There is nothing wrong, of course, with a chancellor keeping people apprised of the risks that face the economy. But there is a danger, coming after a year in which consumer confidence in Britain has had its best run for more than four decades, that people and businesses overreact to such warnings and they become a self-fulfilling prophecy. The hope has to be that they do not drink too deeply his dangerous cocktail. If they do, 2016 will be “mission critical” for the economy, to use the chancellor’s words, for the wrong reasons.

One thing that should be knocked on the head is the idea, which emerged from some interpretations of Osborne’s speech, that an early rise in interest rates from the Bank of England is inevitable, and that he was preparing the ground for it.

As noted last week, a rise in rates this year is marginally more likely than not but could still very easily not happen. The Recruitment and Employment Confederation said on Friday that pay growth for permanent jobs, crucial to the Bank’s thinking, has slowed to a 26-month low.

More than that, the more that Osborne’s fears about the global economy come to fruition, the significantly less likely a rate rise. If the backdrop remains one of volatile stock markets, weakening global growth and a plunging oil price, the Bank will not be raising rates.