Maastricht Convergence Programme debate
Robert Skidelsky
Hansard | Friday, May 25, 2012

I take it that the question for debate this evening is not whether Britain is on track to meet the Maastricht budget criteria, but why, nearly four years after the economic collapse of 2008, our country finds itself officially back in recession.
Since July 2010, the policy for recovery has been set by the coalition Government. The main plank of that policy has been an accelerated programme of deficit reduction. Since the coalition came to office, recovery has gone into reverse. In 2010, Britain's economy grew by 2.1 per cent. In 2011 it grew by 0.8 per cent. With today's figure showing a fall of 0.2 per cent in the last quarter, the OBR forecast of 0.8 per cent growth this year has been exposed as a fantasy. I feel sorry for the Treasury official who wrote in paragraph 6.1 of the convergence report, just published:
"We still expect the economy to avoid a technical recession with positive growth in the first quarter of 2012".
The truth is that the economy is smaller now than it was in September 2010. According to the latest NIESR report, the present slump is the longest in British history. Naturally, the Osborne Treasury denies that its recovery policy was in any way responsible for the non-recovery. A correct policy, it claims, was derailed by external shocks such as the rise in import prices, the euro crisis, the structural impact of the financial crisis, and so on. Now the extra bank holiday for the Diamond Jubilee will apparently be a further impediment to growth this year, so the Queen joins the list of shocks. No, these are excuses, not explanations. The policy was wrong from the start and would therefore never have got us out of the hole into which we had fallen.
The eurozone crisis, for example, which has now spread from the Mediterranean to Holland and France, results from exactly the same austerity policy that is being implemented in this country. I never believed that the policy would work, either to promote recovery or to meet the Government's own deficit targets. Speaking in this House on 1 November 2010, I said:
"I have never been able to understand how cutting the budget deficit in present circumstances is supposed to help employment and growth".-[Hansard, 1/11/10; col. 1501.]
I still await enlightenment.
Chart 2.4 of the convergence report shows that the ballooning of the Budget deficit in 2009-10 was almost entirely caused, as the noble Lord, Lord Eatwell, has pointed out, by the collapse of national output. This ballooning was quite common, and there is a good comment on it dating from 1931, penned by none other than Keynes, who remarked that the rise in the deficit was,
"nature's remedy for preventing business losses from being ... so great as to bring production altogether to a standstill".
It has always seemed bizarre to me to believe that the best way to eliminate a deficit caused by the collapse of output is to pursue a policy that retards the recovery of output. The OBR itself estimated in 2010 that every 1 per cent of GDP decline in current government spending knocks 0.6 per cent off economic growth. It believes that without the Osborne cuts in government spending, GDP in 2016 would be 2 per cent higher than forecast-that is, nearly £50 billion higher. Translate that into extra jobs and houses, schools and hospitals that will not be built as a result of current policy.
That brings me to a second bizarre feature of the Treasury document, which is almost too arcane to discuss in polite society. Most people understand the notion of the deficit; it is the gap between what Governments spend and the revenues that they raise in taxes. The task that the Chancellor set himself in his first Budget was to liquidate not the deficit but the "structural" deficit-the deficit that would remain after the economy had recovered and actual output was again equal to potential output. Unlike the actual deficit, the structural deficit depends on estimates of such things as potential output, the output gap and the trend rate of growth-all intellectual constructs to which a high degree of uncertainty attaches, yet the Government have tied their programme to this particular shaky mast.
One might suppose that the actual deficit would shrink as the economy recovered. The structural deficit, though, has to be eliminated by policy; that is the argument. The latest OBR forecast shows it on track to fall from 7 per cent of GDP in 2010-11 to 0.7 per cent in 2016-17. En route to this mandate that the Government set themselves, something very mysterious happened. The structural deficit, which had been chugging along at about 2.5 per cent in the Brown years without causing any alarm or increasing the national debt, suddenly turned into a structural deficit of 8.9 per cent in 2009-10, with the threat of large permanent additions to the national debt. How did a deficit mainly caused by the cyclical downturn mutate into a structural deficit that threatened the Government's long-term solvency? That was the mutation that caused alarm bells to ring and anathemas to be rained down on the Brown Chancellorship for having left his successors such a horrendous mess to clean up.
The Treasury report suggests two interesting reasons for the mushrooming of the structural deficit. The first, in chart 6.2, is that the pre-recession economy had been growing above trend. The actual level of output, it claims, was 2 per cent above the potential level consistent with inflation in the long term. Since the inflation rate was almost always below the target of 2 per cent between 2000 and 2007 and the Treasury's current assumption of the sustainable level of unemployment, at 5.25 per cent is exactly the same as the rate that prevailed in the Gordon Brown years, it is difficult for me to understand why the Treasury thinks that the pre-recession level of output was too high.
The second explanation, in paragraph 2.8 of the report, is something that the noble Lord, Lord Eatwell, referred to: that the crisis itself has left potential output 11 per cent below its pre-crisis trend. In other words, the economy will emerge from the slump permanently smaller than it was before the recession. Again, no explanation is given for this assertion. Of course, if your policy closes down capacity, it is quite likely that you will get that result. It is on this mixture of assertion, slippery definitions, and dodgy calculations that the logical foundation of the present policy is built. The Government and Treasury clearly believe in the power of incantation-if they say often enough that their policy is restoring confidence and credibility, that will make it true.
Some time last year the penny started to drop and the Chancellor produced his Plan for Growth, a belated admission that deficit reduction is not itself a growth policy and that the Government cannot just stand back and wait for the private sector to spontaneously ignite. There were a lot of measures designed to stimulate growth: lower corporation tax, bigger capital allowances, enterprise zones, green investment and so on, and now a £20 billion credit guarantee for bank loans. The measures are useful but too small, and will hardly offset the 25 per cent reduction of public capital spending this year alone. So much for the Treasury's claim that the Government have been,
"using the savings over the Spending Review period to fund infrastructure investment critical".
That claim is simply wrong.
It is clear that the main plank in the Government's growth strategy is what the report calls "monetary activism", defined as,
"additional monetary stimulus through quantitative easing".
There was £200 billion of it in 2009-10, and the Chancellor has recently authorised another £125 billion. Studies have shown that this is useful; it has raised GDP growth by between 1.5 per cent and 2 per cent more than it would have been in its absence. And yet the effectiveness of additional quantitative easing is far more limited-there are fewer bonds left to buy and less scope to move bond yields-so this source of growth is, at best, highly uncertain.
We are sure to get out of this recession; we always do. If, however, we are to escape from semi-slump in a reasonable period of time, we have to break free from Angela Merkel's strategy of bringing Europe to a standstill and take some initiatives of our own. The noble Lord, Lord Eatwell, has made some suggestions, and I add three of my own. First, in its April world economic outlook, the IMF advocated "balanced budget fiscal expansion"-that is, tax increases matched by increases in government spending, a fragment of forgotten wisdom from the Keynesian era. Secondly, we could follow the example of Ireland and set up a bad bank to buy illiquid assets from the banks at fair present value, aiming to minimise losses to the taxpayer from their later realisation. That would address one cause for the much noted breakdown in bank lending. At least Ireland is growing, which is more than we are. Thirdly, I have long been an advocate of setting up a national investment or infrastructure bank to afford institutional investors such as pension funds a higher yield than they can earn on gilts. I believe that we will be driven to one or other of these unorthodox measures in the end-so why not act now, without wasting more time on excuses?