The chancellor’s credit easing plan is basically borrowing to boost the economy. Is this a sensible approach or would infrastructure spending be a better alternative?
Over recent months the UK’s growth problem has become dire. Independent forecasters continue to slash their predictions for 2011, with the Ernst & Young Item Club now expecting just 0.9% growth. In response, the chancellor has floated plans for ‘credit easing’ for smaller companies – a potentially radical shift in strategy from the simple austerity of the cuts agenda.
But as the global sovereign debt crisis worsens, is this ill-defined plan really the most fiscally credible strategy for growth?
Plan A – the government’s attempt to boost the economy primarily by cutting public spending – is looking a little battered. With the UK’s main export markets facing anaemic growth, the chances of a strong export-led recovery any time soon look very slim. And domestic consumption by government and households – the main source of growth for years – is shrinking. But given all the grim warnings from ministers about the perils of over-indebted states, what alternative is there?
The government is right to be cautious about extra borrowing in a sovereign debt crisis. A credible plan to cut the deficit is central to maintaining investor confidence. But, unlike households, economies have to grow their way out of their debts just as much as they have to get a grip on public spending. The pursuit of fiscal credibility therefore calls not for austerity but for judicious use of the limited borrowing headroom the government has.
So it is encouraging that the chancellor will set out plans to get credit flowing to SMEs through credit easing. We’ll have to wait until the Autumn Statement on November 29 to find out how it’ll be done, and on what scale. Whatever the detail, it represents a radical shift in the government’s stance.
The plan will involve the government – yes, the same one that keeps going on about the evils of borrowing – issuing more bonds and getting deeper into debt. It can get away with this politically because financial transactions like this don’t appear on the headline ratio of debt to gross domestic product. But it is nevertheless an important symbolic departure from the government’s previous position that ‘further borrowing is not the way out of a debt crisis’.
The effectiveness of credit easing to spur growth will depend on a number of things, including the scale on which it’s done. There is also a big question about whether there’s actually much demand for credit out there among SMEs. After all, why should they start borrowing to invest if the rest of us are too busy paying off our credit cards to buy their products?
If it’s going to have much impact on the economy then, the new plan will have to offer lots of credit at attractive rates. That will mean the Treasury taking on a fair amount of risk, probably from banks issuing SME loans – something that could give investors the jitters as they price in that risk.
So, despite being a monetary intervention, credit easing is not a fiscal free lunch, and perhaps not the most fiscally credible stimulus plan the Treasury could embark upon.
The question then is: if the government is going to borrow to stimulate the economy, what is the most growth-enhancing thing it could do with the extra cash? Boosting SME lending is just one option. An alternative is funding a temporary VAT cut, as proposed by the shadow chancellor. The risk here is that most of the stimulus leaks abroad in the form of imported goods.
A third strategy would be to slow the pace of public spending cuts. But apart from the fact that this will probably happen inadvertently anyway, intentionally deviating from the plans for current spending might look like political weakness to investors.
Better than any of these alternatives would be a state-led investment strategy for chargeable infrastructure. By the end of the decade, hundreds of billions of pounds of investment will be needed to upgrade our creaking transport and energy infrastructure.
Deploying cheap public finance for chargeable infrastructure projects such as toll roads could boost demand in the short term, creating jobs; expanding the potential of the economy in the long term; and, crucially, paying its own way by charging service users, leaving taxpayers off the hook.
The government has conceded that it is sensible to deploy the public sector balance sheet to grow the economy and make the public debt burden more bearable. But using that cash in a more growth-enhancing way will be seen by bearers of UK government debt as a more fiscally credible strategy than a risky credit easing scheme. The latter might have the advantage of flattering the UK’s headline debt figures and confusing political opponents, but it won’t fool the bond market.
