Don’t expect fiscal stimulus to work any better than monetary easing at reviving the economy, as desperate measures undermine confidence
When in a hole, it helps to ask whether we are digging ourselves out or digging ourselves deeper. We’re certainly in a hole, and we should be asking that question now.
Growth in Scotland’s economy has slumped to zero. Retail sales are flat. There’s a projected budget deficit of £14.8 billion on the Holyrood books. Despite consistently higher spending, Scotland’s map is still disfigured with red areas of multiple deprivation.
Policy response? A renewed “conversation” on Scottish independence, a detailed study of “Scotland’s place in Europe” – and calls for more public spending.
It seems the greatest heresy in Scotland today to suggest that each one of these responses may be making our hole even deeper than it already is. Were it a simple matter of moving beyond Holyrood hand-wringing over Brexit given the mounting evidence that economic Armageddon has not descended, we might start to feel a bit better.
And if we left behind that endless “conversation” on independence with its falsehood that our economic malaise can be treated by endless constitutional wrangling, we might escape at last from Holyrood Groundhog Day.
But escape from our hole is not so simple. For we’re not the only economy that’s in it. And the idea that we need simply apply the usual stimulus measures – further cuts in interest rates, more quantitative easing and greater spend on infrastructure – is now under growing question.
What we are experiencing is something much more troubling: a breakdown in conventional economic theory and the deeply flawed modelling that has supported it. Time and again, economic forecasts have proved to be wide of the mark, and not just over instant Brexit misery. More fundamental policy errors have come to light.
What were seen as temporary “emergency” measures in response to the global financial crisis in 2008 – historically low interest rates and effective money printing – have failed, even after eight years, to achieve the expected results of a sustained revival in economic growth.
Indeed, each new cut in interest rates – now down to 0.25 per cent, with a further cut to zero not ruled out – looks to have failed. People have not responded in the manner expected in conventional economic modelling. Yet this is a field that should surely be familiar with concepts of behavioural response and the law of diminishing returns.
Who is really surprised that as returns on savings have been officially throttled down, people have responded, not by a spending splurge but by borrowing less or saving through other means? The more desperate the official “emergency” response seems to be, the more sceptical people are about its sustainability and the more they fear a sudden reversal of fortune. Economists seem to have forgotten their roots: they are, after all, a species of behavioural scientists. Paying more attention to real world behaviour than to computer models would seem long overdue.
Having thus failed on the monetary stimulus front, the policy pendulum is now swinging back towards fiscal stimulus: higher spending and borrowing by governments. The prevailing orthodoxy till now that government debt and borrowing had to be reduced is now to be stood on its head: more borrowing is now “good”, the preferred means of funding programmes of infrastructure spending and public works.
By this means jobs will be created and private spending boosted. But a precondition for a general move towards fiscal expansion would be abandonment of the battle against growing government budget deficits.
Governments of Eurozone member states, bound by the budgetary limits laid down in the Growth and Stability Pact, would have to “reverse ferret” for this fiscal stimulus to happen. And here in Scotland, our fiscal deficit, currently at 9.5 per cent of GDP and double that of the UK, would prove a mere staging post.
If it is behavioural response that is looked for – that is, a widespread pick-up in business confidence, investment and borrowing – fiscal reflation may be better achieved by reducing tax rates rather than increasing government expenditure. But in the political world, greater kudos is seen to flow from prestigious infrastructure spending programmes, whether or not they raise business activity elsewhere.
And the system is now well addicted to the tax revenues flowing in – and dependent on those to keep rising. Take business rates, for example, now bringing in £2.9bn in revenue to Holyrood, some 40 per cent more than four years ago.
Who can really be puzzled by the sluggishness of business growth and investment when you keep adding to the business rates burden? There is now a compelling case – as the Scottish Retail Consortium and the Scottish Chambers of Commerce powerfully re-stated last week – for business rates to be pegged, if not cut. It is a big disincentive for small and medium-sized companies.
It also presupposes that money lavished on government projects is well spent. But economic history is littered with examples of white elephants and ill-conceived spending. And today argument rages about the mooted benefits of the HS2 rail project, with cost estimates ranging from £42bn to more than £80bn. Where is the cost-benefit analysis?
Meanwhile, the argument for more borrowing also rests on a belief that business and personal spending response is impervious to ever higher totals of government debt. But it is fear of higher taxation ahead, almost as much as an actual tax increase, that works to suppress spending behaviour. People will hold back in anticipation of a tax clobbering ahead.
This is the greater hole we find ourselves in. Official response to date – and certainly the orthodoxy reigning across the SNP administration – is that more public spending and more debt is the optimal way forward.
But is it? If continual warnings about the supposed “Brexit recession” are not already undermining confidence in the enterprise sector, further resort to sky-high borrowing may prove the killer for any such recovery.
• In my column last week I referred to the Censis centre in Glasgow, one of eight “funded by the Scottish Innovation Council”. This should of course have read “the Scottish Funding Council”.