WITH even the IMF changing its tune on the merits of austerity, the Chancellor has a big decision to make, writes Peter Jones.
How much of a risk-taker is George Osborne? Tomorrow, when the Chancellor presents his somewhat tardy autumn statement on the economy, which now amounts to a mid-year budget, we will find out. My fear is paradoxical: that he is as conservative as his party label suggests and, in plotting a path which looks like avoiding risks to the economy, he will actually end up taking a bigger risk.
A striking chart published in the Ernst & Young ITEM Club economic forecast this week and reproduced here shows what the problem is. It is an austerity versus growth chart for several countries covering the years 2010-12. On the vertical scale it plots economic growth as a percentage of GDP. The horizontal scale shows how much austerity (tax increases plus public spending cuts) is being inflicted, also as a percentage of GDP.
The message is pretty clear – the more austerity in an economy, the less growth there is. In the current rather desperate fiscal climate, where you would want your country to be is where Germany is positioned – recording growth of about 2.5 per cent a year with minimal austerity. You don’t want to be where Greece is – tax rises and spending cuts adding up to nearly 5 per cent of GDP and the economy shrinking by a similar amount.
This, however, doesn’t mean that if you abandon austerity, growth resumes. The other problem is dealing with the fact that the government is spending more than is being raised in taxes (the deficit) which is increasing the total amount of government debt. That cannot go on indefinitely, otherwise the country eventually winds up broke, like Greece.
Mr Osborne has made it plain that getting spending and taxes back into balance so he can start reducing total debt is his over-riding priority. His plan to do this, mainly because of poorer than hoped-for growth, is now off track. He hoped to be able to start reducing debt in 2015-16, but the Institute of Fiscal Studies now thinks this will not happen until maybe as late as 2017-18.
The IFS reckons that this means Mr Osborne will have to find another £23 billion of tax rises or spending cuts during this period. But then the big question is: what will that do to growth? The IFS, being an outfit that deals more with taxes and spending than with the economy, does not say.
Growth, however, is just as essential to Britain getting out of the debt hole as is austerity. Indeed, it is arguably more essential. The more growth you have, the more taxes are raised and the bigger is GDP, which means that not only is the deficit cut by closing the gap between revenues and spending, it also gets reduced as a percentage of GDP.
This is essentially what Christine Lagarde, head of the International Monetary Fund has been arguing in recent months. A year ago, the IMF was a staunch supporter of austerity, but it is now saying that too much fiscal medicine has been administered and the patient is not getting any better because of it. That matters not just for the UK or European economy, but for the world economy. If Europe has no growth, then there is reduced demand for goods from China and India, depressing their economies.
UK growth figures over the last three years have also been depressing – a reasonable 2.1 per cent in 2010, tailing off to 0.9 per cent in 2011 and thought likely to be a dismal -0.2 per cent this year.
But a look at the Ernst and Young chart suggests that it is perhaps not quite so depressing when compared with other economies. Growth has been about 1 per cent a year, not brilliant but better than nothing and, moreover, slightly better than might be expected given the amount of austerity that has been imposed.
This also suggests that Mr Osborne does not need to impose more of it. Rather, he could pin his hopes more on growth to bring Britain out of the debt hole. Why should we believe this is a better way?
The growth that matters comes not from the SNP’s pet demand for increased spending on infrastructure (it would help but not by very much) but from consumer demand for goods and services which is a big engine of economic growth. Cutting tax relief on pension contributions to raise more in tax revenue, one much-leaked likely measure, won’t hit demand, but cutting welfare payments to the poor will because they spend most of the income they get.
It also sends a fearful message to voters that hard times are getting harder, making it more likely that people will cut back their spending further. That trickles down the chain – shops sell less, so buy less from suppliers and so on, causing more increases in unemployment.
And if more austerity is Mr Osborne’s message, then it will be coming at a time when some signals are emerging that the worst of the post-recession stagnation may be behind us. Yesterday the Bank of England released figures suggesting that its Funding for Lending Scheme might be working. The increase in high street bank lending to individuals and businesses since the scheme was introduced in August is tiny – a mere £496 million – but it is moving in the right direction.
Though Britain still has far too much private (as well as public) debt, new lending to finance business expansion is a necessary feature of growth, and is also needed to reduce private debt.
And, remarkably, bright signs are appearing in Europe which suggest that the eurozone crisis is on the mend. In a briefing issued yesterday, Ian Stewart, Deloitte’s UK chief economist, noted that Greek and Portuguese debt problems look to be under control and the European Central Bank’s bond-buying programme has cut the cost of government borrowing.
Longer-term trends also show that some of the imbalances which have caused the eurozone problems are coming back into line. Citing two studies from big institutions, he says: “Both reports argue that the peripheral euro area countries have made significant progress in restoring competitiveness. Labour costs are heading down, fiscal deficits have fallen sharply and exports are growing.”
Believing that Europe is fixing its problems is probably inconceivable to a Conservative UK Chancellor. But if Europe is healing, a bet by Mr Osborne on a bit of growth now could well be a lot less risky and eventually pay a better reward than an overdose of austerity.