Chris Watling: So which leader is right about the economy, the Keynesian or his rival?
Sunday 11 April 2010
So who's right, Gordon Brown or David Cameron? Brown tells us that Tory plans to forego part of the rise in National Insurance will take £6bn out of the economy, as it means cuts of the equivalent amount in spending this current fiscal year. Cameron views the tax rise as a tax on jobs, and therefore a tax on recovery.
Their difference in opinion goes to the heart of economics. If you're a "Keynesian", as Brown is, then you believe the purported "fragility" of the recovery means it still needs to be supported by government spending – as such, reducing that planned spending by £6bn increases the risk of a double dip. If you're of the opposite view (whether a believer in sound money, Ricardian equivalence, free markets and so on), then you'd prefer to place the emphasis of the burden of growth upon the private sector and not on government – as such, increasing the cost of employment doesn't make sense, as it discourages private-sector job creation.
So which theory is right?
Fortunately, there are precedents from which we can learn lessons. In Japan, in 1990, two bubbles burst: a stock market bubble and a "real estate and debt" bubble. The Japanese authorities took a Keynesian approach to dealing with the aftermath. Interest rates were cut to zero – albeit over five years; banks were cleaned up and recapitalised, eventually, while successive governments engaged in successive fiscal stimulus plans – the "do whatever it takes" approach to ensure the worst effects of economic contraction were avoided.
The result of Japan's Keynesian approach to the bursting of its bubbles has been two decades of economic stagnation – generally referred to as Japan's "lost decades". On top of that, Japan hasn't worked off its excess or solved its problems. Indeed, the debt bubble built up during the boom years in the corporate sector has simply been passed to the government sector. Corporate debt at its peak in 1990 was 85 per cent of GDP. It's now fallen to around 50 per cent. Government debt to GDP, however, has moved in the opposite direction from 50 per cent in 1990 to approximately 200 per cent today. We call it "Pass the debt parcel". Japan now has the highest government indebtedness problem in the developed world by far, coupled with an ageing and shrinking population to support it. This is not a problem solved – it's a problem postponed and arguably magnified.
At the other end of the spectrum lie the countries involved in the Asian crisis of 1997-98, most famously South Korea, Hong Kong, Thailand and Indonesia among others. As in Japan's case, bubbles built up and then burst (primarily related to over-indebtedness, property and a poorly run financial sector). In these instances, though, the authorities in each country had little choice over how to deal with their crises – an international buyers' strike of their debt, and associated capital flight, meant they had to go cap in hand to the International Monetary Fund for a loan. The IMF provided the cash but, as always, with conditions. Interest rates had to be raised to defend the currency, fiscal policy had to be consolidated and government spending cut aggressively, while the banking sectors were also cleaned up.
While their downturns at the time were painful and deep, once the excess capacity created by the bubble was cleared by those recessions, these economies were returned to good health and have since been growing rapidly for over a decade (other than two or three quarters at end 2008 and early 2009). Most importantly, today these economies remain structurally strong with low private and government debt levels, high savings rates and strong productivity growth.
These precedents provide important lessons for today. Brown's approach mirrors that of Japan's these past two decades – more fiscal stimulus; do whatever it takes and ensure, with government spending and artificially low interest rates, that the worst of the contraction is avoided – thus risking condemning Britain to our own lost decade. Cameron's approach, while different in some respects, comes much closer to the Asian crisis model of 1997-98, that is, consolidate government finances, cut spending and get the Government out of the way of the private sector.
Indeed, their differing approaches are likely to lead to distinctly different market reactions to whoever wins power on 6 May. Cameron's approach, if properly executed, should result in a rally in gilt prices (fall in yields), as fiscal tightening follows from the first Budget promised within 50 days. With that, we would anticipate looser monetary policy for longer (the corollary of tighter fiscal policy) and stability or a mini rally in sterling, as confidence in Britain returns – sterling is, after all, cheap (with the one caveat that for that rally in sterling to occur, there must be no more quantitative easing or hints of QE – printing more than your neighbours creates currency weakness and, with that, inflation, however much spare capacity exists. To demonstrate the point, think of Zimbabwe a few years ago – high inflation and high unemployment.
Brown's approach of spend today, consolidate tomorrow will be greeted, if he wins power or some semblance of power-sharing, with weakness in gilts (rising yields), for several reasons. First, he has no economic credibility – this is after all the Chancellor who promised every year since 2002 to balance the Budget within three years or so, yet has delivered deficits now for nine consecutive years. Second, Labour, having turned its back on the City, is now primarily funded by the unions – as such, any attempt to cut government spending is likely to be challenged by its paymasters. Third, for any government, cutting the failures among one's own policies is never easy. And fourth, historically, most major fiscal consolidations that place the burdenon tax rises rather than spending cuts have been shown to fail. Look at Ireland in the early 1980s, and Britain in the late 1960s. The reason is simple: raising taxes reduces the economy's productive growth potential – thus undermining your attempts to grow out of your problem.
So while there's no easy or pain-free way out of a financial crisis, recent precedents would support the view that there really is only one free lunch in economics: productivity driven by innovation that in turn is driven by the private sector. One of the few principles in economics is that while governments can support economies in their hour of need, in and of themselves they have no wealth-creating ability. Within reason, the less government, the better, as that frees up resources in the rest of the economy with which the private sector can innovate, drive productivity and create wealth. On this, I'm afraid, Brown is wrong, Cameron right.
What we need are tax breaks to help spread jobs across the country
There are certain elephants in the room that politicians from all the mainstream parties don't seem to want to discuss. Most obviously these include immigration and Europe, and are the main reason why newer parties, such as UKIP and the BNP, seem to be gaining traction.
But while many of us love the cultural diversity that comes from immigration, a radical rethink of policy is required. Six million adults are claiming out-of-work benefits; 1.6 million on the claimant count (ie the dole); 1.7 million on income support; over half a million on employment and support allowance; and more than 2 million on incapacity benefits.
That total has remained around the same level for over a decade. But, according to the latest National Statistics labour-market data, more than a million new jobs have been filled by immigrants in the past six years alone. It would appear that the Daily Express had it right last week with its headline: "1.7 million jobs and 92 per cent go to immigrants". Immigration should be restricted to genuine political asylum seekers and those who fill skills shortages – so unnecessary strain is not placed on public services. At the same time, government policy should be directed towards getting benefit claimants into work. Indeed, given the heavy reliance of the adult population in the North-east, Wales and Scotland on benefits and government jobs – 40 per cent of workers in Wales, 38 per cent in the North-east and 37per cent in Scotland are employed by the Government, while in all three regions there are more people on incapacity benefits than are employed in manufacturing – the next government should consider creating economic zones (ie with company tax breaks) in those areas. Those would serve to attract manufacturing and other businesses, to start generating jobs and get the number dependent on government largesse lowered.
It would also lead to a more balanced growth picture across Britain rather than the current South-east centric growth model.
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