Workers and businesses are in for a far worse time than need have been the case
Many big ideas in economics have been tested to near-destruction this year, from the permanence of the euro to the resilience of China. In Britain, the biggest of all has been the ideology behind George Osborne’s historic spending cuts. This was the year when voters and investors got to see whether the chancellor’s big idea stood up. It doesn’t; and the result is that workers and businesses are in for a far worse time than need have been the case.
Like Gordon Brown, Mr Osborne moved into the Treasury with a clear sense of what was wrong with the British economy, and ideas about how to fix things. The Osborne diagnosis was summed up in two words: crowding out. His remedy could be described in just three more: expansionary fiscal contraction.
In his debut budget, the chancellor argued that a bloated public sector was “crowding out” businesses. Hack back the state and interest rates and taxes would drop, giving companies room to grow. That was expansionary fiscal contraction, and ministers made much of how Canada pulled it off in the mid-90s.
To which all one can say is: Ottawa 1, Westminster 0. For every post created in the private sector between July and September, 13 were lost in the public sector. Nor are things likely to turn around soon. The UK will probably slip back into recession before spring is out, with unemployment officially tipping over 3m not long after. In last month’s autumn statement, Mr Osborne gave up waiting for the private sector to turn up and announced subsidised loans for small firms, along with a little extra cash for public works. The austerity carries on, only now without an underpinning ideology. While it is debating policies and presentation, Labour should not lose sight of the fact that, in his critique of the cuts, Ed Balls was spot-on.
How did Mr Osborne get it so wrong? First, his diagnosis was upside down: the private sector was being propped up, not crowded out, by the public sector. As the economist Michael Burke points out, in the last three months of 2009 public investment was 20% higher than before the recession, which boosted GDP and encouraged private investment. When the coalition laid out its huge spending cuts, companies tightened their belts too.
Second, Mr Osborne underestimated the role of overseas demand. Canada wasn’t an example of successful austerity as much as free-riding on a booming US economy. The UK must rely on a bust Europe. Finally, the mantra of “public bad, private good” never added up. Business has always relied on the state for markets (as with pharmaceuticals and defence) and its inputs. Sadly, that economic common sense has been buried under crude politics.