Many people feel torn on big economic questions.
The arguments are often complicated, so they look at the politicians on each side and back the ones they trust the most – or distrust the least. It’s comforting to be surrounded by kindred spirits. Sometimes, though, a little voice starts to intrude, saying, “Hang on a minute. This doesn’t feel quite right.”
That happened to me in the late 1980s. I’d always been instinctively cosmopolitan, internationalist and hence pro-European. So when the pro-European political establishment – Labour, the Lib Dems and the less nutty Tories – said it would be a good idea for Britain to join the Exchange Rate Mechanism (ERM), I instinctively sided with them.
And then the little voice of logic started to intrude. I realised that this artificial alignment of very different economies was going to end up like a Procrustean bed: those that were too long to fit would have their feet chopped off, and the others painfully stretched. There was no way that one size would fit all in the ERM – and even less so in the euro.
The trouble was that the only politicians saying this were on the far right of the Tory party. And most of them were anti-European. These were not my people. They were far from kindred spirits. But the awful truth was, they were right. So I backed my head rather than my heart, and within a few years I was helping to lead a public campaign against Britain joining the euro.
A decade or so later, many of us feel the same internal wrangling, this time over how best to deal with the deficit. I used to be infuriated by Gordon Brown’s refusal even to say the word “cuts”. So when the Coalition, in 2010, said it would eliminate the structural deficit in one Parliament and bring total debt down by 2015, my instinct was that these people were serious, and it had to be done. It would hurt, but it would work.
After a few months, though, the little voice came back. What if it hurt but didn’t work? What if the cuts took so much growth out of the economy that they would be self-defeating? In a column in August 2010, I wrote, “If tax revenues fall, we could end up with large spending cuts, a spiral back into recession and a deficit just as big as it was before. That would be the worst possible outcome both for the country and for the Coalition.” And so it has proved.
I argued that the Tories could have pacified the markets with less stringency. They could have promised, say, to cut the deficit by three-quarters in one Parliament instead of eliminating it. That would have sounded more serious than Labour was, and markets were anyway more likely to trust Conservatives.
It may seem odd to argue that cutting less could have had more effect on the deficit. It’s counter-intuitive. But the mistake is to think of the national economy as a household. If I’m in debt, the more I cut my spending, the more quickly I’ll pay off my overdraft. It’s not so simple when you’re a government, because so much of the rest of the economy depends on your spending.
When government cuts spending, jobs go, companies lose business, people have less in their pocket. There is also a dampening effect on business and consumer confidence, so both are more reluctant to spend. And if growth shrinks, so do tax revenues, so the deficit doesn’t narrow. It’s as if, to go back to the household example, my spending cuts also hit my income, so my overdraft remains the same. In both cases, everyone is worse off, with no corresponding reward from lower debt.
Of course, economists disagree about the extent to which government spending affects growth. It’s called the multiplier effect: a multiple of one means that the economy shrinks by £1 for every £1 cut in government spending. Until recently, the consensus was that the multiplier in the UK, after taking account of the boost to the economy from a looser monetary policy, was about 0.5, which meant that although austerity would have some bad effect on economic growth, it could at least make inroads into the deficit. With that multiplier, the IMF calculated that the spending cuts had reduced our GDP by 2.5 per cent in the two years after the election.
Now, however, after two years of failure on debt and the deficit, it is time for a reassessment. And sure enough, in October the IMF admitted that its estimate of the multiplier had been far too low. Far from 0.5, it was more likely to be between 0.9 and 1.7. That suggests that the hit to our GDP from austerity has been at least 4.5 per cent, possibly much more. No wonder tax revenues have fallen so much. No wonder the underlying deficit is as big as it was in 2010 if you exclude the one-off boost from selling off the 4G spectrum.
Even the Office for Budget Responsibility has changed its mind. In a little-noticed section of its report on Wednesday, it argued that the problem in the UK economy is not one of supply, as it used to think, but a deep shortfall in demand. That demand isn’t going to come from exports to other countries, as yesterday’s dreadful trade figures showed. So it can only come from personal spending, government spending or business investment in this country.
Businesses won’t invest while the demand for their goods is so low. People won’t and can’t spend when their wages and benefits are falling in real terms. The only way to boost demand, and therefore growth, is for government to delay some of its austerity and start building roads or cutting taxes.
It won’t affect our borrowing costs. Our AAA rating is likely to be downgraded anyway because of our lack of growth; and we will still be a safer haven for investors than the eurozone. What it will do is give our sickly economy a boost, which should, in turn, increase our tax revenues and turn a vicious circle into a virtuous one. And if that puts me closer to the camp of Ed Balls, I shall just have to swallow hard and put up with it.