George Osborne’s strategy is failing, leaving him in need of a drastic reversal of fortune
The budget of 2012 was a famous ‘omnishambles’, with many of its measures reversed within months. George Osborne was determined to avoid a repeat in the 2013 budget. Its measures were designed to appeal to aspiring voters – help with mortgages and childcare, a penny off the pint, the freezing of petrol duty rises, and the bringing forward of the £10,000 income tax allowance. Instant polls showed broad popular approval.
The reception by market analysts and political commentators, particularly Conservative commentators, has been much more critical. That suggests this year’s budget may eventually damage Osborne’s reputation even more than the last one because of his perceived inaction in response to an economy which stubbornly fails to improve. .
Most of the budget’s headline measures were dismissed as clever electoral stunts with little economic significance, but there was alarm about the risk of stimulating a new house price bubble through the help-to-buy scheme. There was also deep gloom about the medium-term economic prospect that the budget barely addressed. Hardly any independent observer thinks that Osborne has a credible strategy for repairing the economy.
Osborne did little to correct this impression by his selective presentation of figures and the partisan arguments littering his speech. The Institute for Fiscal Studies has shown how the spending figures were manipulated to avoid the embarrassment of the deficit being higher this year than last, when the true picture is that the deficit is stuck at £120 billion, and debt is still rising. But this sleight of hand allowed Osborne to claim that the Government has already cut the deficit by a third, and to suggest that it is, as promised, on course to eliminate the whole deficit.
In reality, the Government has missed all its targets and now expects debt to continue rising, peaking at 86 per cent of GDP in 2017-18. But even this outcome depends on official assumptions about future economic growth and tax revenues being correct. Most analysts find them implausible, since predictions about growth have so far proved overly optimistic. They may be wrong, and Osborne right, and he will certainly hail any improvement in growth before the next election as a vindication of his strategy. A return to sustained long-term growth looks much further off.
Where does this leave austerity? The opposition complains that the Government has been pursuing a draconian austerity policy which has choked off growth. Conservative critics of the Government complain that the cuts have been minimal, and that the total of public spending is continuing to rise. Both claims have some truth.
The Government did choke off recovery by cutting some budgets hard in its first three years, particularly capital spending and local government, which has been very hard hit, but it has also ring-fenced other areas – the NHS, foreign aid and pensioners’ benefits – and continues to adopt new spending commitments, such as personal care for the elderly. It does have dramatic plans for cutting welfare and all other department budgets (local government is scheduled to receive an overall cut of 50 per cent by 2017), but most of these cuts lie in the future, and have now been pushed back until after the next election when Osborne himself may no longer be Chancellor.
Osborne is commonly viewed as being fixated on short-term electoral considerations and scoring points against political opponents. But this view underestimates him. His judgements as Chancellor reflect electoral calculation, but also correspond to deeper beliefs about the economy and how it works. One of the most powerful of these is his faith in capitalism, his confidence that something will always turn up. The requirement placed on those in government is to be patient and allow time for the spontaneous forces of recovery to emerge. The task is not to substitute the government for the private sector but to remove obstacles in the latter’s path. One way to do this is through appropriate fiscal and monetary policy. Osborne describes himself as a fiscal conservative and a monetary activist, but he is much more of the latter than the former.
A true fiscal conservative like Andrew Mellon (US Treasury Secretary at the time of the 1929 financial crash) believed in increasing taxes to bring down the deficit and raising interest rates to make the household and corporate sectors pay down their debts. If Osborne had followed this strategy house prices would have collapsed, unemployment and bankruptcies would have soared and the Government might not have survived. But the basis for a much quicker and more robust recovery might have been laid.
This is Tea Party fiscal conservatism, but Osborne rejects it, to the dismay of many in his party. Under him the deficit has not been eliminated and debt is still rising. Yet Osborne believes in the need to shrink the state and announced in 2010 that the ratio of spending cuts to tax increases in reducing the deficit should be 80:20. He wants to reduce the share of government expenditure in GDP to 40 per cent, the average for the post-war period.
Public expenditure rose as a percentage of GDP after the 2008 crash because the economy suffered such a large contraction in 2009 (it still has not regained its pre-crisis peak). Osborne argues that the public sector must be scaled back to the lower level of GDP to allow the private sector once more to take the initiative. So far, however, he has only announced plans to scale back the public sector, rather than actually scaling it back. This is deliberate. He expected that a symbolic commitment to austerity, together with tough restraint on budgets and spending cuts in some areas, would restore confidence and promote a private-sector recovery.
But that does not mean that his strategy has been to implement a drastic retrenchment of public spending, as some of his critics allege. His policy has been to promise cuts but then in most cases delay their full implementation until the recovery is well established, and this explains his active monetary policy, encouraging the Bank of England to pump money into the economy through quantitative easing to prevent any collapse of prices. It has duly done so – £375 billion so far.
There is a magic money tree after all, and it grows in Threadneedle Street! Quantitative easing has kept interest rates at historically low levels, triggering a massive redistribution between savers and debtors (and robbing bank depositors on a much grander scale than anything attempted recently in Cyprus). But while it has staved off deflation and helped the pound depreciate it has not yet brought about recovery.
One of the most significant announcements in the budget is, therefore, the new discretion to be given to the Bank of England in making growth as well as inflation a priority. This has been widely interpreted as signalling that the Government wants to see inflation higher, as a means to reduce the burden of the debt, as well as to provide further incentives to the private sector to bring about the recovery.
In a nutshell, Osborne’s problem is not that he lacks a strategy, but that so far it has not worked.
The active monetary policy has helped engineer a major devaluation of sterling (around 25 per cent) which should have substantially stimulated exports. So far this has not happened, and potentially this is the most worrying feature of all about the British economy, as Ha-Joon Chang has pointed out, although it receives little attention in the policy debate.
Instead of focusing on productivity and supply-side issues Osborne’s latest ploys to kick-start recovery are to encourage another escalation of house prices, to redistribute £58 billion over six years to companies’ already bloated reserves through the reduction in corporation tax and to tolerate higher inflation while allowing real wages to fall still further. He is pulling every monetary lever he can in the belief that sooner or later the private sector will respond and lift the British economy off the rocks. After all, it always has.
But the length of this recession is beginning to cause anxiety. The longer the recovery is delayed, the worse the fiscal problems facing whoever is unfortunate enough to be elected in 2015. Osborne likes to boast how the British Government has much greater flexibility than governments in the eurozone, because it can control its interest rates and its exchange rate. Yet despite the Government utilising this flexibility, the British economy has not performed any better than the eurozone average and seems stuck in the same long-term depression.
The deep structural weaknesses of the British economy make it very hard to rebalance without a long-term industrial strategy to replace the failed financial strategy. Osborne rejects this analysis. Yet the current prospect is that, even by 2017, the recovery will still be only weakly established, the deficit as a result will not have been brought under control, debt will be on a rising curve, living standards will be falling, and inflation rising. At some point in the next Parliament decisive action to tackle Britain’s economic problems will become unavoidable, but because Osborne has been postponing that moment of decision the situation will have become significantly worse.
Osborne is still hoping something will turn up to rescue him or his successor, while continuing to blame his difficulties on the mess he inherited and the crisis in the eurozone. These excuses are wearing thin as the problems facing the British economy mount. Osborne desperately needs a change in the economic weather, but his means of effecting one are steadily diminishing.