The splintered opposition to fiscal austerity
Samuel Brittan Financial Times 21/10/11
What has a logical error to do with the economic doldrums in which many countries find themselves? Absolutely everything. The error in question is the "fallacy of composition". This is defined by the Oxford Dictionary of Philosophy as that "of arguing that because something is true of members of a group, it is true of the group as a whole". The application to economics is to suppose that the principles of sound finance, such as avoiding debt and balancing the books, that may apply to a family or small business are applicable to governing nations. Despite economic stagnation and rising unemployment, most industrial countries, with the honourable exception of the US under the Obama administration, are engaged in fiscal austerity. These programmes are likely to fail in their own budget-balancing terms because of their kickback effects on growth; but that is not the main argument against them.
George Osborne, the chancellor, likes to boast he is at the head of the pack; and so he is, almost, in terms of dire results. I refer not so much to the 5.2 per cent inflation rate. However much populists may sneer, this is a temporary bulge, albeit made worse by the ill-advised increase in value added tax at the beginning of the year - the official index of consumer prices excluding the effects of indirect taxes rose by 3.7 per cent. Scoffers might note CPI fell from a 5.2 per cent increase to a 1.1 per cent rise in the 12 months to September 2009. So it can drop.
The main problems relate to the real economy. UK gross domestic product on the last count was 2.8 per cent above the recession trough of 2007-08, the smallest recovery of any major industrial country except Italy. Unemployment had been the one relatively bright spot compared with other countries - although that reflected labour hoarding and temporarily low productivity growth. But it is now on a sharply rising trend. The Item Club estimates suggest domestic demand this year is falling slightly. Hopes of even a very modest recovery rest on an increase in net exports - very doubtful in view of the international situation. The best one can say about the UK economy is that it is what Ed Balls, the shadow chancellor, calls "flat lining". In other words output is stagnating. This contrasts with 2-3 per cent annual growth required to prevent unemployment and excess capacity from increasing. (Disregard the self-serving pessimistic downgrades of UK growth potential.) The one bright spot is the large corporate profit surpluses, which remain uninvested.
It is a bit pathetic to hear the governor of the Bank of England resting his hopes on China, Japan and Germany raising "domestic spending". If they did they would soon be blamed for triggering a renewed rise in material and energy prices. Meanwhile, homegrown ideas for restarting the economy are cropping up on all sides. Recent examples include temporary VAT cuts, selective reductions in national insurance contributions, increasing university places, a spending voucher for every adult, a national investment bank and an income tax holiday. These and many other ideas simply fragment the opposition to misguided austerity, which is one reason why I am extremely reluctant to contribute to the various symposia on the subject. What the economy is short of is demand; and if that is too abstract to grasp, call it the flow of spending in the economy. The individual bright ideas would make more sense as alternative or additive ideas for boosting demand. How we do it is secondary. An analogy would be if, instead of discussing whether to go from London to Glasgow or some place else, squabbling motorists were sidetracked into arguing about the secondary question of which route to take. Meanwhile, the official side has been preoccupied by an undignified struggle between the Bank and Treasury about taking the lead in increasing credit supply.
It is often forgotten that the government's fiscal target is stated in terms of the "cyclically adjusted current budget balance". This provides two sources of manoeuvre: the cyclical adjustment and the capital account. The cyclical adjustment is not a matter of hard science, even when conducted by the Office of Budget Responsibility. But it does enable the government both to justify the existing deficit over-run and some additional relaxation. Moreover almost 10 per cent of government spending, amounting to more than £30bn ($47bn) a year, is classified as "net investment" and thus outside the target. All in all there is ample room for stimulus should the government so decide. It is true that there is a supplementary requirement for public sector net debt to fall as a percentage of GDP by 2015-16. But whether it will be or not is anyone's guess. As Cassius said to Brutus in Shakespeare's Julius Caesar, if we do not pull ourselves out of this unnecessary stagnation, the fault "lies not in our stars but in ourselves that we are underlings".
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Contact - samuel dot brittan at ft dot com