Britain is experiencing a different type of downturn, based on an asset price bubble. It requires, in turn, a different response involving public investment in infrastructure
Poor George Osborne. When he took on the job of chancellor the narrative seemed so simple. The outgoing government had sustained a high level of public expenditure through increasing amounts of borrowing. When the financial crisis came, the impact of recession, coupled with the need to bail out the banks, meant that borrowing and debt had soared to eye-watering levels.
The coalition government’s Plan A was to bring borrowing down to manageable levels by the end of the current Parliament, by cutting public spending rather than increasing taxation. Economic theory said the loss of public sector jobs would be more than matched by private sector employment growth; tax revenues would recover; borrowing costs would be kept down; and the country would end up with a broader spectrum of more efficient public service delivery bodies.
But as the chancellor prepares to announce his Autumn Statement, things are not coming out as planned. Instead of bouncing back, economic growth has flat-lined. Public sector job losses are not being matched by private sector job creation, with higher unemployment and a rising welfare bill. Inflation is soaring, putting pressure on middle-income families. Voters are becoming agitated about the loss of services, and a younger generation has been radicalised by the prospect of higher personal debt and lower career expectations.
Moreover, the continued crisis in the eurozone and the flagging US economy seems likely to make the UK situation worse not better.
What’s gone wrong? Put simply, it’s the wrong sort of recession. It is not a ‘normal’ recession that can occur as an economy becomes uncompetitive, experiences major technological change, or finds its products and services are out of fashion. In these cases, the economy can go into a steep decline before recovering at a higher level of growth.
But the current economic situation is more to do with balance sheets consequent on an asset price bubble. Households, businesses, and banks find themselves with assets that are no longer worth what they paid for them, but with the debts of acquiring them still outstanding. In these circumstances they act defensively, reducing their own spending as much as possible to reduce their debts. Collectively, these actions are disastrous. They remove demand from the economy, depressing growth and leading to a further recession – the double-dip.
Reducing public spending adds to this problem. It increases unemployment; depresses demand; increases the welfare bill; and reduces tax revenues, so creating a greater debt reduction target for the government. On latest estimates, the planned reductions might achieve only half of the government’s debt reduction target by the end of this Parliament.
If Osborne sticks to his policies rather than taking the Plan B approach of stimulating the economy, he could go into the next election with the job half done, offering voters another Parliament of pain. Slowing down his austerity policy in the hope of promoting growth wouldn’t work either because balance sheet recessions take a long time to work through. In 1990s Japan, it took 10 to 15 years.
Yet, the Japanese experienced positive growth over that period without sending the economy into a tailspin of depression. Their plan involved high levels of public investment in infrastructure such as roads, rail and telecommunications. This provided direct work for the construction industry, added to aggregate demand and growth, kept down the welfare bill and improved the infrastructure needed for the private sector to flourish.
The investment was paid for by increasing borrowing in the short term and letting the credit rating ‘go hang’, accepting that higher interest rates and long-term debt repayment requirements were a better option than a double-dip recession. They also recognised that monetary policy was ineffective in a balance sheet recession because no one wants to borrow, even at zero interest rates.
Is this a risky policy? Yes it is, but perhaps it is a better one than the grind of low-growth austerity.
Malcolm Prowle and Roger Latham are respectively professor of business performance and visiting fellow at Nottingham Business School. Their book, Public services and financial austerity: getting out of the hole, is published by Palgrave Macmillan
