Chancellor plays a losing game, but Ed’s dead right

George Osborne took a risk by cutting public spending - and he lost. Now he seems to have no idea how to respond, leaving all the cards in the hands of his opposite number

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New England was supposed to get another humdinger of a storm. A foot or more of wet, heavy snow was forecast to start falling on Tuesday morning and to keep going until the next day. Bad weather always presents a dilemma for our local school superintendent, who has to make a decision by around midnight whether he will close the schools the next day.

School buses go all around our town, often up slippery mud roads to pick up kids and take them home in the afternoon. Caution has to be the watchword. If you don’t close and there is bad weather, that could be disastrous. Closing when there is bad weather is fine. The kids get a day off, and they make it up with an  extra snow day scheduled at the end of the year.

This week, the superintendent called it early and there was no snow at all; it rained all day. No big deal though: nobody blamed him for being careful. The risk of not calling it right and then being blasted with masses of snow was not worth taking. That set me thinking of some other policymakers we know who weren’t so cautious and made the wrong calls. They spun the roulette wheel and lost.

The belief that George Osborne and his inexperienced adviser Rupert Harrison had in 2010 was that cutting public spending would create rapid growth in the private sector, which had been ‘crowded out’. So there would be an expansionary fiscal contraction and all would be well.

Losing gamble

Sadly, it didn’t turn out that way. They failed to consider the downside risks of being wrong, and generated bad outcomes rather that the good ones they dreamed of. They let the schools open, and the killer storm hit. They gambled with people’s lives and lost big time. As might be expected, the polls are beginning to reflect the nation’s doubts about the Bullingdon boys’ competence. 

Humiliation on the economy was followed by a devastating defeat for the Tories at the Eastleigh by-election. Interestingly, on the day that the Tories were pushed into third place in one of their must-win seats, the latest YouGov/Sun poll had Labour with a 13-point lead. The Tories increasingly have an image problem: more than half believe it appeals to one section of the country rather than the nation as a whole. 

A paper published in the Economic Journal this week shows how reckless the choice of austerity was when the economy had just started recovering from the biggest shock in a hundred years. In a devastating critique, Huixin Bi, Eric Leeper and Campbell Leith of the University of Glasgow examined in a paper entitled Uncertain Fiscal Consolidations the macroeconomic consequences of fiscal consolidations such as the one the coalition has undertaken.

They found that because very restrictive conditions exist for any fiscal consolidation to work, which did not apply in 2010, such fiscal contractions are most unlikely to be expansionary. And so it was. The bad economic news confirms that austerity has failed miserably. GDP growth in the fourth quarter was unrevised at minus 0.3 per cent although there were minor revisions to back data, which meant that growth in 2012 was 0.3 per cent. Manufacturing and service output was down on the quarter – the estimate for services was revised down to minus 0.1 per cent. Exports fell 1.5 per cent while government spending increased 0.6 per cent: next to no sign of the economy rebalancing.

Four of the last five quarters have been negative; excluding the one-off growth of 1 per cent in the third quarter of last year – entirely down to the burst to activity from the Olympics – the economy has grown a total of 0.2 per cent in the nine quarters since Mr Osborne took over. That was put in perspective when the US had its fourth-quarter number revised up from a small decline to positive growth.

Since the start of the tax year in April 2012, government borrowing has totalled £93.8bn, excluding a one-off boost from the transfer of Royal Mail pension assets. This is 1.6 per cent higher than at the same point in the 2011-12 tax year, so the deficit is rising, not falling.

Too late

The latest CIPS/manufacturing survey added to the growing body of evidence suggesting that the first quarter is likely to be negative and we are headed into triple-dip. The Purchasing Managers Index fell from 50.8 to 47.9, which implies contraction, its lowest level since October. The output balance weakened from 54.3 to 49.1 which, as Capital Economics has  noted, is at a level consistent on the basis of past form with quarterly falls in manufacturing output of  0.5 per cent.

The fall in the employment balance from 49.8 to 47.1 is a 40-month low, and may well indicate that the news in the labour market is set to worsen. Downside risks to the UK economy from the $85bn spending cuts that seem to be about to hit from the sequester in the United States are adding to the government’s woes.

This week, Paul Tucker floated the idea that the Bank of England could start paying negative interest rates on deposits. This is probably unlikely to happen because of its impact on savers, but it does signal a willingness to adopt a more flexible approach to monetary policy.

As news on the economy continues to worsen, I fully expect the Monetary Policy Committee to do more quantitative easing in the next couple of months, with Mr Tucker joining the doves. Mr Osborne took a risk and lost – and appears to have no clue how to respond. All he seems able to do is to blame everyone else and sneer. It’s too late now to turn things around by 2015.

So my friend Ed Balls, who has been dead right on the economy, looks a racing certainty to take over as Chancellor in two years’ time, and possibly even sooner.

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