The real mistake was not getting the forecast wrong, but getting the economics wrong. Look back to the last recession.
guardian.co.uk, Friday 4 May 2012 10.00 BST
The UK economy fell back into recession in the first quarter. But talk of a double-dip recession misses the bigger picture – we’ve now had 18 months of essentially no growth, and more than four years after the start of the recession, the economy is well over 4% below its pre-crisis peak. The latest forecast from the National Institute of Economic and Social Research isn’t for another deep recession, but for no growth this year, and that we won’t get back to pre-recession levels until some time in 2014 – six full years on. Already, this is this is the slowest recovery on record, comparing poorly with what happened after the Great Depression.
The official forecast at the time of the June 2010 “emergency budget” was that we would now be growing at over 2.5%, with unemployment falling sharply. This was hopelessly optimistic. But getting the forecast wrong was not the government’s main mistake. Everyone gets forecasts wrong – we were too optimistic as well, albeit not by nearly as much. The point is that the government got the economics wrong. What the last 18 months has given us is as clear a test as you could ask for (in the messy real world of economics) of two competing worldviews.
The first was that, as the chancellor said then, “reducing the deficit is a necessary precondition to growth”: cutting the deficit quickly would restore consumer and business confidence, and allow lower interest rates, which would lead to growth. In other words, you can’t spend and borrow your way out of a recession.
The second, advocated by the likes of Martin Wolf and Paul Krugman, was the view that this was precisely wrong: the government deficit was the counterpart of excess private sector saving, as households tried to reduce their debts and businesses – knowing that the demand wasn’t there – held back from investment. Cutting the deficit too sharply would just make things worse. In other words, you can’t cut, tax and save your way out of a recession. As for low interest rates, they too were the result of a depressed private sector, trying to save too much and invest too little.
What have we seen since then? Not just low growth, but also, as a direct result, continued very high deficits. Indeed, in the past year, the deficit on current spending hardly changed, with almost all the reduction in the total deficit coming from cuts in investment spending. Hardly surprising therefore that it was the construction industry that was the biggest drag on growth in the latest figures.
But despite this continued high borrowing, long-term interest rates have remained very low, the result, as even a quick look at the data reveals, of a lack of investment opportunities far more than “confidence”. The markets have indeed spoken. As Wolf says, “they are saying: borrow and spend”.
What should the government do? There are plenty of alternatives, none of which involve abandoning the necessary medium-term goal of fiscal sustainability. Boosting investment spending now would boost growth, create jobs and would have no direct effect on the government’s primary fiscal target. Alternatively, or additionally, a “balanced budget expansion”, as advocated by the Social Market Foundation and the IMF, could achieve the same objectives. Either way, with long-term government borrowing as cheap as in living memory, with unemployed workers and plenty of spare capacity and with the UK suffering from both creaking infrastructure and a chronic lack of housing supply, not investing now is simply to ignore the most basic principles of economics.
The prime minister, of course, is not listening: his response to the GDP figures was to reiterate that “the solution can’t be more debt”. But perhaps he should look back to the last recession. In the then-chancellor Norman Lamont’s recovery budget of 1993, he famously, and controversially, raised taxes. But not immediately. He explicitly said that he would not raise taxes or cut spending right away, thus “allowing the recovery to take hold”. In fact, the government didn’t start cutting the structural deficit at all until 1994-95; by which time the economy had been growing for 18 months, by then at a very healthy pace of over 3%.
So Lamont grasped the basic economics, and got the timing right. I should know: I was his (civil servant) speechwriter. So should David Cameron: he was his (political) special adviser. Sadly, he appears to have learned the wrong lessons.