Friday, 7 December 2012

The Autumn Statement, and a Challenge for Economists

This week has been dominated by the Chancellor’s Autumn Statement, a mini budget which set out the economic position of the UK, and the policy consequences. However you look at it, the news is grim. Real terms cuts to benefits, increased taxes in pensions and a bleak outlook suggesting that it will be many years before the economy returns to healthy growth are the order of the day.

I want to take a step back and suggest that, strategically speaking, the statement was actually less than meets the eye. No big change of direction was announced, although the situation is so dire that a shift in course might well be warranted. There are arguments that Britain should be on a different path, and I think it is worth bringing these to your attention, despite my limited knowledge of economics.

The statement itself was broadly speaking a continuation of the policy of economic austerity that was initiated in 2010. The underlying analysis is that Britain is suffering the effects of a debt crisis caused by excessive borrowing in the years leading up to the crash. A bloated and unproductive public sector, funded by borrowing, is dragging the economy down and crowding out productive investment in the private sector. This situation is unsustainable, and public borrowing must be brought down in order to free up resources to invest in the private sector. The spending cuts and tax rises in the statement are an attempt to do this. The problem that the Chancellor has is that the dire growth forecasts indicate that this is not working. As far as I can see, there are two major theoretical alternatives to this policy, which I shall set out below.

The first is that the policy is not working because it is self defeating. When public spending is cut demand is sucked out of the economy. In very crude terms all those sacked public sector workers are no longer spending their wages in local shops, so those shops go bust as well. The fewer businesses there are, the fewer there are paying tax, and the harder it is to pay off the public debt. The answer is fiscal stimulus, i.e. maintain high levels of public borrowing to maintain demand until the private sector recovers, and let this growth pay down the debt. This is the diametric opposite of the UK’s current economic policy.

The second alternative is that the policy is failing because it is too timid. The deficit (let alone the debt) is not being reduced because the measures announced so far are small in relation to the problem. Radical supply side reform and really drastic cuts are needed. This means (and these are random examples from off the top of my head) things like abolishing employment protection to make employing people cheaper, abolishing useless government departments (e.g. Culture, Media and Sport) slashing benefit programs like tax credits and other such policies. Only then will the conditions for economic growth be present.

For once I’m going to admit ignorance. I am not an economist and I do not know which approach, if either, is correct. If anybody does write anything from a position of knowledge in the comments I will, with permission, publish it as a full post. Blog rules apply; nothing over 600 words, assertions must be linked to credible sources where possible, and nothing which requires specialist training to understand. The floor is yours.   

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