Time to rethink our deficit strategy? John Humphrys discusses the still-sinking UK economy
Just when summer had finally arrived and the start of the Olympics offered a welcome distraction to those who like such things, a dose of cold reality came pouring over our heads this week.
On Wednesday the Office for National Statistics released figures showing that the economy is sinking even deeper into recession. In the second quarter of the year it sank 0.7%, the third quarter in a row in which the economy has been shrinking and all of us have been getting poorer. The economy is now smaller than it was when the Coalition Government came to power over two years ago. So is it time now for a policy rethink?
What's causing the downfall?
Economists had been expecting bad news, but none forecast that it would be this bad. So perilous is it that some commentators are now predicting that Britain will lose its triple A credit rating before too long as investors start to lose faith in the country’s ability to pull itself around. That would be a very public defeat for the Government’s whole strategy for restoring economic growth through first dealing with the huge deficit it has been trying to reduce.
Others are warning us not to jump to conclusions too fast. They argue that the figures may be artificially bad because of various one-off factors. The Diamond Jubilee gave us all an extra bank holiday that inevitably had knock-on effects on economic output. And the terrible weather, especially in June, severely hit the construction industry whose figures for the quarter were especially bad.
Yet others question whether these figures even give an accurate picture of what is actually happening in the economy. That’s because different statistics seem to tell a different story. Both employment and tax revenue have been rising in recent months and output surveys among employers paint a more optimistic picture. Some parts of manufacturing, such as the car industry, are booming.
In short, we cannot be sure exactly what is happening in the economy.
At best we are merely coasting along the bottom of a trough and at worst we may be sinking more deeply into it, but ether way the overall picture is still pretty awful.
The economy is 4.5% smaller than it was before the financial bubble burst back in 2008, setting in train the global economic recession we have suffered since. This means that in Britain the last four years have seen the most sustained period of economic slump in peacetime for a hundred years or so. Even though the depression of the 1930s was much deeper than the one we are going through now, recovery from it was much quicker.
And that’s what was thought would happen this time round too. Both the Government and an assortment of economic forecasters were confident, a couple of years ago, that the economy would be picking up well by now.
So why isn’t it?
The Government says it’s because the problems were a great deal worse than anyone realised at the time and because factors beyond its control have turned out to be much more difficult for us than anyone imagined. In particular, the crisis in the Eurozone, which constitutes a half of our export market, overshadows everything. And the clouds there are getting heavier rather than breaking up. Not everyone is persuaded by this explanation, They point out that within the Eurozone most countries are doing better than we are.
The Labour Party says the explanation lies in the Government’s having been far too zealous in pursuing an austerity policy. It has cut “too far and too fast” and is still cutting. After Wednesday’s figures came out Ed Balls, the Shadow Chancellor, said: “These shocking figures speak for themselves. As we warned two years ago, David Cameron and George Osborne’s ill-judged plan has turned Britain’s recovery into a flatlining economy and now a deep and deepening recession.”
But Labour’s critics say their proposal for a rather more relaxed approach to cutting the deficit would not really have made much difference because it too recognised that big cuts in spending and rises in taxation were necessary. Some of the cuts in public sector investment, from which the construction industry is now suffering, were announced by the last Labour chancellor, Alistair Darling. The difference between what the Government is doing and what Labour says it would have done just wouldn’t have been significant.
Cutting the deficit
The problem the Government faces, though, is that although it can claim success in having already cut the deficit by a quarter, as the economy shrinks the amount it has to borrow (as a proportion of the economy) actually rises. In other words, the deficit starts to grow again. The Government has already had to extend the time it gave itself to remove the deficit.
That’s why some economists, as well as Labour, are arguing that the only way to reduce the deficit in the long-term is to increase it in the short-term in order to keep the economy growing. But the Government worries that this would spook the markets: that overnight the historically very low rates of interest it is now charged on money it borrows would rocket up. Then we’d find ourselves in the position Spain and Italy are in - with unsustainably high interest rates.
So instead of increasing its own borrowing to stimulate growth, the Government has been relying on the Bank of England to promote growth by a different route. The Bank has pumped £375bn into the economy by buying up government bonds from the banks in the hope that the extra money in the banks’ coffers would then be lent out into the wider economy so boosting growth. But this hasn’t happened, or not on anything like the scale ministers hoped. That’s because the banks have largely held on to the cash to build their capital and strengthen their balance sheets after the damage done to then during the financial crash.
The Government is trying other means to get activity going again, by helping to make it cheaper for businesses to borrow money and by underwriting investment projects carried out by the private sector. But no one is under any illusion that this can produce quick results. The Prime Minister himself has warned that things are going to stay tough for many years to come.
For some it’s all quite simple. After the bursting of the bubble, there was always going to be a long period of bust. After the boom both the private sector and the public sector were left with huge overhangs of debt, which both would need to remove before either could start spending again. What we are going through now is that slow, painful period of adjustment, they say. Tweaks can be made to policy here and there, but there is no alternative to just sitting it out.
But is that fatalism justified? And how far does the economy need to shrink before it can start to grow again? Those are the questions we are now facing as we realise that the future has turned out to be much bleaker than most of us expected. Enjoy the summer and the Olympics while you can!
What’s your view?
- Were you surprised by the output figures or not?
- Does the picture of an economy shrinking sharply tally with your own experience of what is happening in your area or in the part of the economy in which you work? And how are you personally affected?
- Do you think Government policy is making things worse, better or having no effect at all?
- Should the Government increase its borrowing in an attempt to stimulate growth?
- Are there any specific measures you think the Government should take to get the economy moving?
- And how long do you think it will be before we can start enjoying a steadily growing economy again?
Let us know what you think.
