By sticking to Plan A, the government is missing an opportunity to boost growth. If there is a further eurozone crisis, the chancellor may have to think differently in his 21 March Budget
Eighteen months ago, the chancellor set out the coalition government’s approach to economic policy. George Osborne argued that deficit reduction was the priority and if it were delivered, growth and jobs would be generated in the private sector. The government could help the private sector only by getting out of its way: by cutting corporation taxes and axing regulations.
With the economy having expanded by just 0.5% over the past year and unemployment at its highest rate since 1996, this approach is no longer sustainable politically. The government has to be seen to be doing something more positive; hence the announcements on infrastructure, youth unemployment, housing and credit easing that preceded the Autumn Statement.
The new measures are welcome and specifically target weaknesses in the UK economy. But the chancellor has still stuck to his Plan A for deficit reduction. As a result, he is failing to tackle directly the most urgent problem facing the economy: a lack of aggregate demand.
His argument is that to do so would risk losing the confidence of the bond markets. The result would be higher interest rates, which would damage economic growth and offset any benefits from extra government spending or lower taxes. His critics argue that the bigger risk is not supporting the economy when household and business confidence are depressed and the effects of the eurozone crisis are about to be felt in the UK.
The latest economic forecasts offer more support for the chancellor’s opponents than for him. They suggest private sector spending is unlikely to expand in coming months, leaving the economy teetering on the brink of a return to recession and unemployment likely to rise further.
The Office for Budget Responsibility now believes GDP will increase by just 0.9% in 2011 and 0.7% in 2012. Unemployment in 2013 is forecast to be 8.6%, compared with 5.2% just before the recession.
Therefore, a real plan for growth is required, one that starts by identifying what the economy needs to start growing. In the medium term, this means increasing the supplies of capital, labour and land and using them better.
But in the short term it means boosting demand. With our main export market heading into recession and household and business confidence low, only the government can provide the extra demand. But this would mean relaxing the pace of deficit reduction, which the chancellor is not prepared to do.
Will he take the same approach if the growth outlook continues to worsen? Current policy dictates any further increase in the borrowing forecasts will necessitate spending cuts or tax increases. Will Osborne be prepared to tighten fiscal policy as the economy deteriorates? If the eurozone crisis escalates, we might find out in March.
Tony Dolphin is senior economist at the Institute for Public Policy Research
