The economy shrank in the last quarter of 2010. John Humphrys asks: Does the Government need a Plan B?
The shock news that the British economy actually shrank by half a per cent in the last quarter of 2010 has raised alarm about which way the economy is heading. The retiring director-general of the Confederation of British Industry, Sir Richard Lambert, has accused the Government of failing to articulate a vision of how it’s to achieve growth. And the new Shadow Chancellor, Ed Balls, says the Government’s policies are actually making things worse. Ministers, however, say they are sticking to their guns. But is there a need for a Plan B?
The British economy started to pull out of the recession about a year ago but since last summer the rate of growth in the economy has been falling. So everyone expected the figures for the last quarter of 2010 to be poor. But no one forecast that they would show that the economy had actually shrunk.
The Chancellor, George Osborne, blamed the ‘very disappointing’ figures on the unusually bad weather in late November and December. No one disputes the severe effect such a freeze can have on economic activity, especially in the construction industry. It’s true too that these figures were a first estimate of growth in the last quarter and that such estimates tend to be revised upwards as more evidence comes in. Nonetheless, the Office for National Statistics thinks that at best the last quarter of 2010 was 'flattish'.
But if the clear trend is for faltering growth, then the prospects for this year are not good. That’s because the effects of tax rises (such as VAT) and Government spending cuts have not yet been felt but will certainly be so during the course of this year. Ken Clarke, the Justice Secretary and former Chancellor, says it will take two or three years to get out of the 'real mess' we are in.
Critics of the Government’s approach to the mess say that the fundamental problem is that it’s unclear where the engine for growth and recovery lies. The good news is that exports have been surging as a result of the fall in the value of the pound. As a consequence, manufacturing has been doing well too and increased investment may contribute something to demand in the coming period. In the longer term this is all good for rebalancing the economy back in favour of industry and away from dependence on the financial sector.
In the short term, though, this won’t be enough to power the economy back to growth. That’s because the manufacturing and export sectors are simply too small to do the necessary pulling. By far the biggest source of demand in the economy is personal consumption, which accounts for about 70%. But this is likely to stay stuck in the doldrums. As people try to reduce historically high levels of personal debt, they are going to have to pull in their horns. In any case, they won’t have the money to spend. This year, with inflation outstripping rises in pay, consumers will discover that their real incomes are falling for the sixth year on the trot. With the prospect of interest rates starting to rise again later this year, and the fear of unemployment becoming more pressing, people are just not going to spend.
The conventional solution to such a problem is for the Government to step in and increase its own spending to fill the gap. But that’s just what the Government says it can’t do. Its priority is to reduce the huge financial deficit it inherited. Its target is to eliminate the ‘structural deficit’ (the amount of borrowing it would still be saddled with even after economic growth had returned) during this parliament.
The Government argues that this is itself a strategy for growth. Its case is that by putting up taxes and cutting spending now and over the next four years it is indicating to the financial markets which stump up the loans that it won’t need so much and so will be able to offer less in interest payments on the loans. Such lower interest rates help the economy, it argues. This is what George Osborne means by saying he has 'taken Britain out of the financial danger zone'.
The trouble is that such a strategy takes demand out of the economy in the meantime and that is what threatens growth. George Soros, the hedge fund owner who famously made a fortune betting against British economic policy back in 1992, said at the World Economic Forum in Davos this week that though he supported the Government’s aim of reducing the deficit, 'I don’t think it can possibly be implemented without pushing the economy into recession.'
It’s for this reason that Labour advocates a less ambitious plan for reducing the deficit. It wants it halved in the next four years. Indeed, Ed Balls, before he became Shadow Chancellor, argued that even this was too ambitious and that the Government’s fiscal policy should be targeted on growth not deficit reduction.
Critics of Mr Balls’ Keynesian policy say that that’s all very well but it forgets half of what Keynes taught. Certainly, governments should take on big deficits during recessions in order to keep demand up, but equally they should amass big surpluses during booms to offset them. That, say Mr Balls’ critics, is exactly what the last Labour Government, of which he was a prominent member, failed to do and why the current Government isn’t in a position to spend its way out of trouble.
The Government seems to be well aware that it needs to pursue more than just deficit reduction as a strategy for growth. It promised to publish last autumn a white paper on economic growth but this has not yet appeared. One cabinet minister was quoted as saying that a draft of it was withdrawn because it was 'vacuous'. Nick Clegg, the deputy prime minister, says it is 'work under construction'.
What the elements of such a growth strategy might be remain to be seen. But sceptics say that growth policies which don’t involve government spending in some form are either politically too difficult to deliver (radical freeing up of planning restrictions, say) or end up doing very little for growth. That’s why they believe that if the economy does end up heading back into recession, the Government will have to look again at its deficit-reduction plan. Of the current plan, George Soros said: 'We will have to see it unfold. My expectation is that it will prove to be unsustainable'.
For the moment, the Prime Minister is standing firm. He told the House of Commons on Wednesday: 'The worst thing you could do would be to ditch your plans on the basis of one quarter’s figures'. But some will note the wording of that remark and will be asking: 'Yes, but what will you do if you get two or more quarters of bad figures?'
- What’s your view?
- Do you think the figures showing the economy contracting at the end of 2010 can be put down to the bad weather alone, or not?
- Do you expect your own spending to be much reduced this year?
- Do you think the Government’s deficit-cutting strategy is harming economic growth or is compatible with economic recovery?
- What do you make of Labour’s policy of halving rather than eliminating the deficit over the next four years?
- Do you agree or not with the view that the Government is constrained in pursuing a growth strategy by the Labour Government’s alleged failure to build up an adequate surplus during the boom?
- What policies for directly promoting growth do you think the Government should advocate in its forthcoming white paper?
- And do you think the Government will end up having to think again about how hard and how fast it should be cutting the deficit?
