Keynes said that when circumstances change, he would change his view. The IMF has commendably adopted this approach in its assessment of the UK economy – so why doesn’t George Osborne show similar flexibility?
The International Monetary Fund has been in London recently checking up on the health of the UK economy and deciding whether the Chancellor is prescribing the right medicine for what ails it. Its verdict, delivered in the conclusion of its Article IV consultation, was not as critical of the government as appeared likely from the text of April’s World Economic Outlook, but it did still suggest some policy adjustments were necessary.
In particular, the IMF now sees merit in slowing the pace of deficit reduction in the short-term. It believes this should be achieved by bringing forward planned capital expenditure, so that the government spends more now when private sector demand is relatively weak and less at some point in the future when it has strengthened.
This has been criticised by some as ‘fiscal fine-tuning’, but it makes perfect sense. Increased spending on infrastructure projects not only adds to demand in the economy now, it also boosts its productive potential in the medium-term (which is why it should be preferred to Labour’s option of a temporary VAT cut).
Furthermore, one of the reasons for the weakness of the economy over the last few years has been large falls in construction output, which in the first quarter of 2013 was over 10% lower than it was two years earlier, so extra spending by the government would not ‘crowd out’ private sector activity. And the government’s financing costs are extremely low, making it the ideal time to borrow money to invest in the economy’s future.
The Chancellor will resist the IMF’s call for a change of policy. Although there has been a tacit admission by the government that the cuts in capital spending announced in the 2010 Spending Review were too severe, his solution has been to find extra savings on current spending to finance modest increases in capital spending. Inevitably, this will have less of an impact.
Some of the recent economic data – in particular the 0.3% increase in real GDP in the first quarter of 2013 – have raised hopes that the economy might be recovering from the stagnation of the previous two years. This was perhaps one reason why the IMF moderated its criticism of the government’s economic policies.
However, it is too soon to start celebrating. The forces that have been holding back growth have not diminished. The eurozone economy remains in recession, hitting export growth; wages are still increasing much less rapidly than prices (average earnings were up 0.4% over the last year; prices 2.4%) squeezing households’ spending power; and lending to businesses is still falling, holding back their expansion plans.
Much hope is being pinned on Mark Carney, who takes over as governor of the Bank of England in July, to boost growth through monetary means, but it is not clear what he might do differently to predecessor. Keynes was right: when monetary policy is ineffective and private sector demand is weak, fiscal policy is the only way to boost aggregate demand in an economy.
The Chancellor disagrees and two years ago he had the backing of the IMF. But Keynes also said that when circumstances change, he was prepared to change his view.
The IMF, now backing an increase in government spending in the short term, has shown a similar flexibility. Unfortunately, the Chancellor is proving more rigid in his views and this is one of the reasons why the British economy is less healthy than it could be.
Tony Dolphin is senior economist and associate director for economic policy at the Institute for Public Policy Research
