Osborne's first Budget? It's wrong, wrong, wrong!

Joseph Stiglitz, the Nobel prizewinner who predicted the global crisis, delivers his verdict on the Chancellor's first Budget and tells Paul Vallely it will take the UK deeper into recession and hit millions – the poorest – badly

George Osborne will probably not be very bothered that there is a man who thinks he got last week's emergency Budget almost entirely wrong. But he should be. Because that man is a former chief economist at the World Bank who won the Nobel Prize for Economics for his work on why markets do not produce the outcomes which, in theory, they ought to.

Professor Joseph Stiglitz, who has been described as the biggest brain in economics, is distinctly unimpressed by George Osborne's strategy. This, he predicts, will make Britain's recovery from recession longer, slower and harder than it needs to be. The rise in VAT could even tip us into a double-dip recession.

Stiglitz, who was once Bill Clinton's senior economic adviser, is now professor of economics and finance at Columbia Business School. He was in the UK this week at the University of Manchester, where he chairs the Brooks World Poverty Institute, but he lifted his head from the detail of international development to scrutinise the economic strategy of the Conservative Chancellor whose Liberal Democrat partners recently reversed their judgement that massive public spending cuts now would endanger the economy and joined in the Tory slash-and-burn strategy. They were deeply wrong to do so, he believes.

It would be a mistake to ignore Stig-litz on this. He has a track record of getting his predictions right. He was one of the few economists who predicted the global financial meltdown long before it occurred.

"What happened was very much in accord with what I expected," he tells me when we meet for a coffee outside the Blackwell bookshop in the centre of the university. "The data was pretty clear about that." And the scale of the crash? "That wasn't a surprise," he adds, in a matter-of-fact manner. "The bigger the bubble, the bigger the burst.

"The thing most economists did not fully grasp was the extent to which the banks engaged in murky risk-taking activities. They were taking a risk with our money, their shareholders' money, the bond-holders' money," he says. Banks were demanding up to 40 per cent of the corporate profits, saying their innovative financing was adding value. But "all this talk about innovation was a sham" because it did not relate to any real increase in the economy's productivity, he says.

"There was a prima facie case of something screwy going on [with all the] perverse incentives that would lead them to take excessive risk. But there was no way anyone could know or believe that the banks were [conducting themselves] at that level of stupidity. I predicted that there was going to be a collapse because of the information asymmetry problems that were being created." His Nobel prize was given for exactly that – showing how markets fail because different people in them hold different levels of information.

Yet there is no hint of I-told-you-so about Stiglitz's tone as he asks the waiter for coffee. He orders decaffeinated, but suggests the British economy needs the opposite: a stiff stimulant rather than the "fiscal consolidation" which is George Osborne's economic euphemism for cuts.

Fiscal stimulus is out of fashion now. World leaders embarked on that strategy – injecting money to re-energise the economy – after the banking crash three years ago. It was widely perceived not to have worked because the money governments pumped into the banks was not passed on to ailing businesses or individuals in trouble with their mortgages.

"The problem was that, in the US, the stimulus wasn't big enough," he says. "Too much of it was in tax cuts. And when they gave money to the banks they gave it to the wrong banks and, as a result, credit has not been restored – we can expect a couple of million or more homes to be repossessed this year than last year – and the economy has not been restarted." Instead of producing a consensus that the government should have done more, it has created disillusion that the government can do anything, Stiglitz says.

The result is that, following the attacks by the financial markets on Greece and then Spain, everybody is now in a mood of retrenchment. "It's not just pre-Keynesian, it's Hooverite," he says. By which he means governments are not just refusing to stimulate, they are making cuts, as Herbert Hoover did in the US in 1929 – when he turned the Wall Street Crash into the Great Depression. "Hoover had this idea that, whenever you go into recession, deficits grow, so he decided to go for cuts – which is what the foolish financial markets that got us into this trouble in the first place now want."

It has become the new received wisdom throughout Europe. But it is the classic error made by those who confuse a household's economics with those of a national economy.

"If you have a household that can't pay its debts, you tell it to cut back on spending to free up the cash to pay the debts. But in a national economy, if you cut back on your spending, then economic activity goes down, nobody invests, the amount of tax you take goes down, the amount you pay out in unemployment benefits goes up – and you don't have enough money to pay your debts.

"The old story is still true: you cut expenditures and the economy goes down. We have lots of experiments which show this, thanks to Herbert Hoover and the IMF," he adds. The IMF imposed that mistaken policy in Korea, Thailand, Indonesia, Argentina and hosts of other developing countries in the 1980s and 1990s. "So we know what will happen: economies will get weaker, investment will get stymied and it's a downward vicious spiral. How far down we don't know – it could be a Japanese malaise. Japan did an experiment just like this in 1997; just as it was recovering, it raised VAT and went into another recession."

Then why have we not learned from all that? Because politicians like George Osborne are driven by ideology; the national deficit is an excuse to shrink the state because that is what he wanted anyway. Because the financial market only cares about one thing – getting repaid. And because other European governments are panicking because of the market's wild attack on Greece and Spain, and they don't want to be next.

"But cutbacks in Germany, Britain and France will mean all of Europe will suffer. The cuts will all feed back negatively. And if everyone follows this policy, their budget deficits will get worse, so they will have to make more cuts and raise taxes more. It's a vicious downward spiral. We're now looking at a long, hard, slow recovery with the possibility of a double dip if everybody cuts back at the same time. The best scenario is long and hard ... and the worst is much worse. If any one of these countries is forced into default, the banking system is so highly leveraged that it could cause real problems. This is really risky, really scary."

So what should we be doing? "The lesson is not that you cut back spending, but that you redirect it. You cut out the war in Afghanistan. You cut a couple of hundred billion dollars of wasteful military expenditure. You cut out oil subsidies. There's a long list of things we can cut. But you increase spending in other areas, such as research and development, infrastructure, education" – areas where government can get a good return on the investment of public money. "I haven't done the calculation for Britain, but, for the US, all you need is a return on government investment of 5 to 6 per cent and the long-term deficit debt is lowered."

Taxes also need to be restructured. Osborne has increased capital gains tax for high earners from 18 to 28 per cent. "There's absolutely no reason why you couldn't tax speculative gains [from rising house or land prices] by 40 per cent. There's no social return on it and land is going to be there whether people have speculated or not. But you lower the tax on investment in things like R&D."

Stiglitz has one more practical solution to offer. Governments should set up their own banks to restart lending to businesses and save struggling homeowners from repossession. "If the banks aren't lending, let's create a new lending facility to do that job," he says. "In the US, we gave $700bn to the banks; if we had used a fraction of that to create a new bank, we could have financed all the lending that was needed."

Indeed, it could be done for far less. "Take $100bn, lever that at 10 to 1 [by attracting funds from the private sector] and that's a trillion-dollar new lending capacity – more than the real economy needs."

Such a move would help ordinary people more than all Osborne's rhetoric about being tough but fair. Stiglitz is sceptical, too, about the moral underpinning of a Budget which claims that "we are all in this together", but then hits the poorest hardest.

Analysis by the Institute for Fiscal Studies has suggested that the Chancellor's Budget will cost the poor 2.5 per cent of their income, while the rich will lose just 1 per cent. "I've not made an independent study on that point, but cuts in public services will have a disproportionate effect on the poor," Stiglitz says. Osborne's Budget "may be well-intentioned, but it takes an enormous amount of work to make sure that a package of public spending cuts of that magnitude doesn't hit the poor disproportionately".

His big fear is that overseas aid, which has been protected in this first round of cuts, will not escape a second. "Developing countries have redirected themselves towards Asia, and China in particular, in recent years, so growth in Africa will be more robust than one might have expected, given the severity of the downturn," he says.

Even so, aid remains vital to poor countries. "If aid is cut back, growth will be badly affected," he says. "China is providing aid, but its aid is all in infrastructure, whereas aid from the US and Europe is mainly in education and health – areas in which ordinary people will suffer most if there are cuts."

Joseph Stiglitz has come full circle. What the world needs now – developing and developed – is not retrenchment but greater economic stimulus. It is not a message many are in the mood to hear. But they didn't listen to him last time, either. And he turned out to be right, and they were wrong – and at what a cost to us all.

News
people'It can last and it's terrifying'
Sport
Alexis Sanchez, Radamel Falcao, Diego Costa and Mario Balotelli
football
Sport
Danny Welbeck's Manchester United future is in doubt
footballGunners confirm signing from Manchester United
News
people Emma Watson addresses celebrity nude photo leak
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
News
ebooksAn unforgettable anthology of contemporary reportage
Sport
footballFeaturing Bart Simpson
News
Katie Hopkins appearing on 'This Morning' after she purposefully put on 4 stone.
peopleKatie Hopkins breaks down in tears over weight gain challenge
Arts and Entertainment
Olivia Colman topped the list of the 30 most influential females in broadcasting
tv
News
Kelly Brook
peopleA spokesperson said the support group was 'extremely disappointed'
Life and Style
techIf those brochure kitchens look a little too perfect to be true, well, that’s probably because they are
Sport
Andy Murray celebrates a shot while playing Jo-Wilfried Tsonga
TennisWin sets up blockbuster US Open quarter-final against Djokovic
Arts and Entertainment
Hare’s a riddle: Kit Williams with the treasure linked to Masquerade
booksRiddling trilogy could net you $3m
Arts and Entertainment
Alex Kapranos of Franz Ferdinand performs live
music Pro-independence show to take place four days before vote
News
news Video - hailed as 'most original' since Benedict Cumberbatch's
News
i100
Life and Style
The longer David Sedaris had his Fitbit, the further afield his walks took him through the West Sussex countryside
lifeDavid Sedaris: What I learnt from my fitness tracker about the world
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs General

Year 5 Teacher

£80 - £135 per day: Randstad Education Cheshire: Permanent post for a Key stag...

Geography Teacher

£90 - £160 per day: Randstad Education Birmingham: Geography Teacher urgently ...

SEN Teachers and Support Staff

£50 - £130 per day: Randstad Education Chelmsford: Are you an SEN Teacher or L...

SharePoint Engineer - Bishop's Stortford

£30000 - £35000 per annum + benefits: Ashdown Group: A highly successful organ...

Day In a Page

'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

'I’ll tell you what I would not serve - lamb and potatoes'

US ambassador hits out at stodgy British food
Radio Times female powerlist: A 'revolution' in TV gender roles

A 'revolution' in TV gender roles

Inside the Radio Times female powerlist
Endgame: James Frey's literary treasure hunt

James Frey's literary treasure hunt

Riddling trilogy could net you $3m
Fitbit: Because the tingle feels so good

Fitbit: Because the tingle feels so good

What David Sedaris learnt about the world from his fitness tracker
Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Second-holiest site in Islam attracts millions of pilgrims each year
Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering