Are these hardships necessary?
Samuel Brittan The Financial Times 18/06/10
Contributors to the Financial Times are normally discouraged from using headlines with question marks. But there is a good reason for the present exception. Are These Hardships Necessary? is the title of a 1947 book by the late Roy Harrod, best known as the first biographer of John Maynard Keynes. Politically he might be described as a radical Conservative. The intention of his earlier polemical work was to protest against the miseries inflicted by Britain's postwar government, including even the retention of controls on where people could work.
One should never overdo historical comparisons. Harrod correctly diagnosed the postwar complaint as inflationary demand pressure artificially held back by controls. Today's problem is the opposite one of a deficiency of demand in the aftermath of the credit-crunch induced recession. Known now as the "output gap", this deficiency is put conservatively by the newly created Office for Fiscal Responsibility at 4 per cent of gross domestic product. The analogy remains, however, in the diagnosis of unnecessary austerity due to a misguided macroeconomic policy.
The trick of the British establishment is to turn discussion from "whether to" into "how to" questions. The media debate is on which government services to cut or on the balance between spending cuts and tax increases. Once the discussion has been channelled into these trenches the establishment has won. The real argument, however, should be on whether we need unparalleled fiscal austerity or not.
There is merit in a root-and-branch examination of government activities, asking whether some decisions could be returned to the citizens. But this should be carried out calmly over a period of months and not rushed in a totally unnecessary emergency Budget. Moreover, any good that these reviews might do from the point of view of a genuine market liberal is undone if all savings are channelled into the sacred cause of reducing the Budget deficit more quickly than Alistair Darling planned. David Cameron and George Osborne are behaving like owners of a whelk stall rather than economic managers of a nation with its own currency.
In an agenda-setting speech on June 7, Mr Cameron gave three arguments for wanting to cut the Budget deficit quickly - never mind that until two or three years ago he largely accepted the New Labour economic narrative, including its public spending plans, and concentrated his fire on Britain's supposedly "broken society". The most populist argument was to translate the official projection of a near £70bn annual interest payment on the national debt by 2015 into "schools 'n hospitals" forgone, as every demagogic politician does to bully people into accepting his policies. Never mind that these payments already amount to £40bn and even the most draconian budget will not be able to freeze it at that level. More fundamentally, how many "schools 'n hospitals" will we lose if government policies prolong recessionary conditions unnecessarily? His second argument is that investors "do not have to put their money into Britain". This ignores the fact that, in contrast to Greece, at least two-thirds of government borrowing is financed internally. An expanding economy itself generates most of the savings required to finance Budget deficits, and much else.
His most serious argument concerns the effects of Budget deficits on long-term interest rates. There is the empirical question of how sensitive business investment is to this particular element in its costs. The Cameron argument also assumes that the Bank of England policy has no influence on long-term rates. In the last resort, however, the government can borrow directly from the Bank, a course recommended in such situations not by Keynes but by no less dangerous a firebrand than Milton Friedman.
Mention of the Bank brings one to the nub of the issue. The government's real case is that an expansionary monetary policy will not only offset any contractionary influence of the forthcoming Budget, in the way outlined by Mervyn King in his Mansion House speech, but gradually erode the existing output gap. I would buy this if the Bank rate were 5 or 6 per cent. But it is a much more dubious proposition when it is already near its minimum level at ½ per cent. Of course, "quantitative easing" - jargon for the Bank injecting money into the economy by unusually large purchases of securities - might help. But it is an untried weapon.
We could live with an old-time religion Conservative Budget if the rest of the world stayed with sensible demand management. The real harm is that the British government has tipped the balance in favour of ill-timed financial austerity at gatherings such as the Group of 20. Even then there is some hope that the more pragmatic German and French leaders may make their austerity a matter of words more than deeds. And all is not lost so long as the Obama administration and China's leaders stick to quasi-Keynesian policies.
|Published on www.samuelbrittan.co.uk
Contact - samuel dot brittan at ft dot com