The shambles of Budd’s departure has called into question the independence of Osborne’s Office for Budget Responsibility

Larry Elliott
guardian.co.uk, Tuesday 6 July 2010

George Osborne has been busy since he arrived at the Treasury. He has presented an emergency budget, he has announced a £6bn package of spending cuts, he has abolished the Financial Services Authority, and he has set up the Office for Budget Responsibility to scrutinise the government’s books. The chancellor’s two-month honeymoon came to an end today with the news that the OBR’s interim head, Sir Alan Budd, would be stepping down at the end of the month.

That’s not the way the Treasury sees it, naturally. Sir Alan only had a three-month contract and had always made it clear that he would not be sticking around once Osborne had delivered his debut budget. Although the expectation in Whitehall had been that Budd would remain in place until a permanent chairman was appointed, there was, a Treasury spokesman said, nothing untoward about his departure.

This explanation, it has to be said, does not entirely ring true. At 72, Budd has had a long and distinguished career in public service. He has been chief economist at the Treasury, he was one of the founder members of the Bank of England’s monetary policy committee, and he has run an Oxford college. Osborne would have wanted such a highly respected figure to remain in place until the OBR had been put on a permanent statutory footing, and Budd – however much he might have yearned for the quiet life at his home in Devon – is the sort of person who would see it as his duty to help the chancellor out. Hector Sants, the chief executive of the FSA, was prevailed upon by Osborne to rescind his resignation and help orchestrate the shake-up of financial regulation; Budd would have done the same.

So the suspicion is that Budd is going quickly for another reason – namely, that his independence has been called into question by the shambolic way in which Osborne’s team handled the story, based on a Treasury leak, that the measures in the budget would cost 1.3m jobs across the public and private sectors. The Treasury, to put it mildly, was not best pleased by this story and vowed to “trash” it when it broke in the Guardian last Tuesday, on the eve of David Cameron’s appearance at prime minister’s questions.

The OBR had planned to release its own assessment of the impact of Osborne’s budget measures on the Thursday, which would have been too late for Cameron in his weekly sparring match with Harriet Harman. Fortunately for the prime minister, the OBR’s report – containing the heroic assumption that job losses from the budget would be dwarfed by the creation of 2m new jobs over the next five years – was brought forward by 24 hours. The Treasury said that this was Budd’s attempt to “make a contribution to the debate” rather than a crude attempt to spare Cameron embarrassment. Again, this explanation strains credulity.

But even if it was true, it would still raise doubts about the OBR’s credibility. Bodies that want to be seen as independent do not take actions that – even on the most benign interpretation – could be construed as politically driven. Predictably, the OBR came under a lot of unflattering scrutiny.

Osborne has only himself to blame. The chancellor made great play of how the OBR would prevent politicians fiddling the figures to make budget sums add up: this only works, though, if the organisation is not just squeaky clean but is seen to be squeaky clean. The OBR was meant to be Osborne’s answer to Gordon Brown’s decision – in the first week of the 1997 Labour government – to grant the Bank of England operational independence over interest rates.

Both moves were intended to provide a clean break with the past and show that the new team had radical, reforming instincts. Like the monetary policy committee, the OBR has been welcomed by economists, who think it makes fiscal policy more transparent. There, though, the comparison ends. Albeit working in a more favourable economic climate, the monetary policy committee quickly established its independence. Geographically, it was parked at the other end of town from the Treasury. It quickly set up a group of nine eminent economists to make decisions. And it raised interest rates at four of its first six meetings. There have been times when both Brown and Alistair Darling privately fumed at the bank, but they were careful to avoid treading on the toes of Threadneedle Street.

By contrast, the OBR is currently a three-person committee serviced by macroeconomists seconded by the Treasury. It is physically situated in the Treasury. The Treasury handles all press inquiries. After the shenanigans of last week, these together provide the strong impression that the OBR has been set up to give the new government cover for the most draconian public spending cuts since the war.

That cover now looks a bit threadbare. It is not just that the OBR’s growth and employment forecasts look implausibly strong. It is that its independence has been called into question and will remain in question until it has its own staff, is removed from the Treasury, and reports to parliament rather than the chancellor. Osborne – agree with his politics or not – has made a confident start, but this was a blunder. Far from trashing the story, he has trashed his own creation.

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.

http://www.independent.co.uk/news/uk/politics/osbornes-first-budget-its-wrong-wrong-wrong-2011501.html