George Osborne may duck and dive, but over the last couple of years he has proven that he just doesn?t get it. He has been wrong on the economic theory, wrong on the corrective action, and wrong on the markets. It is time to call him out.
Wrong on the economic theory
Osborne came into office armed with an economic theory ? expansionary fiscal contraction. It states that by increasing business confidence, cuts in government spending can actually be offset by gains in business output.
To put it another way, imagine there is a big hole in the road up ahead. According to the theory, the hole is the future spiking of taxes and interest rates to pay for Britain?s growing debt. As a business you are so worried about that hole that you have already begun to cut back your spending and investments. Fortunately, in steps George Osborne with a deficit reduction strategy that you trust will fill in the hole in time. Future crisis averted, time to start spending again.
Denmark and Ireland has some success with this approach in the 1980s, but Osborne should have realised that Britain in 2010 was in a very different situation.
First, Osborne?s theory assumed that in 2010 it was rising government debt which was holding back business from investing. But businesses were far more concerned about the risk of a double-dip recession, weak demand from consumers who were trying to save rather than spend, and the unwillingness of the banks to lend.
Second, Osborne?s theory relied on businesses being able to very quickly ramp up spending to offset the deep public sector cuts. That was possible in Ireland and Denmark in the 1980s because they were small economies whose businesses could invest in export production for a growing global economy. Britain in 2010 was a big economy whose export partners were already struggling. Osborne has tried to characterise the eurozone crisis as a challenge he only had to face when he came into office, but he spent the election campaign scaremongering about Britain turning into Greece, so that lacks credibility. It should have been clear before the first cut was announced that our trading partners were not an easy route to quick growth.
The IMF has estimated that every ?1 Osborne cut in public spending led to up to ?1.70 being cut in the economy as a whole. So instead of fiscal contraction and economic expansion, Osborne economics delivered fiscal contraction and a double-dip recession.
Wrong on the corrective action
Sometimes everyone gets things wrong, but when it became clear last year that the plan was failing, Osborne took the wrong corrective action. Instead of decisively changing approach he has spent the last year dabbling with a Plan B-lite.
Initially Plan B-lite seems to have been empty announcements intended to steal attention from Labour?s arguments for a Plan B. The November 2011 pledge of ?5bn in extra infrastructure spending in 2014-5, and another ?5bn for 2015-6 is a prime example of an empty promise with no short term impact.
By this summer the collapsing British construction industry and the increasingly critical CBI were getting too vocal to ignore. So in July Osborne announced a pledge to underwrite an additional ?10bn in infrastructure projects. So far the response has been muted and only a handful of projects have signed up with little short-term impact.
So this week Osborne has announced his first pledge of real stimulus money for immediate spending: ?5bn for school building projects over the next two years. Forget that it is only two years since Osborne cut the Building Schools for the Future programme which was spending about ?5bn every two years, or that the money will come from the golden goose of ?Whitehall admin cuts?. The real problem is that you cannot do half-hearted stimulus.
The whole point of a stimulus is to make a big noise about your big stimulus and get a big multiplier on your money by persuading consumers and businesses that it is time for them also to spend big. Confidence in Britain is low, and using the language of austerity while parceling out a little construction cash will not get the animal spirits racing.
Wrong on the markets
In interviews where his policies are criticised, Osborne has one last ace up his sleeve: his policies must be working because of Britain?s low borrowing costs. The problem is that the market is not a schoolteacher grading each country?s austerity package and doling out borrowing cost grades.
Let us look at some numbers. The yields yesterday on 10-year benchmark government bonds in Britain were 1.82 per cent, our public debt as a percentage of GDP at the end of last year was 87 per cent and our projected budget deficit for the year is 7.9 per cent. Compare that to two countries with currency independence: the United States with a yield of 1.61 per cent, public debt of 68 per cent and budget deficit of 7.0 per cent, and Japan with a yield of 0.72 per cent, public debt of 208 per cent and budget deficit of 9.5 per cent. Neither of these countries have a credible budget deficit strategy.
Now take a look at two eurozone countries, France with a yield of 2.03 per cent, public debt of 87 per cent and budget deficit of 4.5 per cent, as well as Germany with a yield of 1.40 per cent, public debt of 82 per cent and budget deficit of 0.2 per cent.
Suddenly our borrowing costs do not look so remarkable. That is because borrowing costs are driven by three main things: the likelihood of default, projections of long-term inflation, and (at least recently) central bank programmes like quantitative easing.
In theory countries like Britain, Japan and the US ought to never default because our debts are denominated in our own currencies and we can print enough money to cover our debts. Setting that aside, if the market thought the Osborne cuts were the only thing keeping us from a high likelihood of default then yields should have jumped on last year?s announcement that the plan was off track. They did not.
Far more important for determining yields are projections of inflation, because if the markets expect higher inflation they will insist on a higher yield to make up for it. Inflation is primarily driven by growth and nobody is predicting much of that at the moment so it is not surprising that yields are low.
Even if growth did look likely, the Bank of England?s use of quantitative easing has pushed down yields by swamping the market with demand. That programme has now been suspended, but if anyone should be taking credit for low borrowing costs over the last couple of years it should be Mervyn King not Osborne. But of course in 2009 Osborne described quantitative easing as the ?last resort of desperate governments?.
He just doesn?t get it
Over the medium term we need to rebalance the British economy and bring down the deficit through a balance of growth and cuts. The chancellor has had two years to learn on the job and he is still failing. He just doesn?t get it and it is time to call him out.
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Jonathan Bailey works for the Generation Foundation which was co-founded by Al Gore and David Blood to mainstream sustainable capitalism. He writes in a personal capacity.
economy, George Osborne
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