Time for Plan B?

Predictably, the heat is mounting on the British government to soften its fiscal policy in light of weak economic growth.  Today the new IMF chief Christine Lagarde seems to be adding to the pressure, even if she wasn’t explicit.  The code for changing this policy is referred to by political types as “Plan B”.  I am now convinced that some sort of Plan B may now be a good idea – but it would not take the form that a lot of Plan B advocates, especially the Labour opposition propose.

First, why?  I have been progressively convinced by the FT’s economics editor Martin Wolf.  I have found him to be easily the most cogent commentator on the current economic situation, better than any number of economics Nobel Laureates or former members of the Bank of England monetary policy committee, who seem to think that their past glories can compensate for the shallowness of their analysis.  Paul Krugman, Ken Rogoff, Joseph Stiglitz, to name a few, have disappointed somebody that has respected their weightier works; David Blanchflower has turned downright silly in order to widen his audience.  Mr Wolf has been consistent, logical, and has gone further than most to try and understand all facets of the arguments.

The problem in the UK economy is not lack of consumer demand, since consumers are right to pay down debt as a priority right now.  The problem is lack of business investment, and a weak world economy, and hence potential export markets.  And excessively tight fiscal policy may send investment into a doom-loop, since so much depends on confidence.  Add to that the fact that current levels of public expenditure are unsustainable, and the massive size of the public deficit, and you will understand that most versions of Plan B are unconvincing.  Reducing the cuts simply creates problems for later, and builds up a false confidence in what this nation can afford.  Cutting VAT temporarily, as advocated by Labour,  addresses the wrong problem.

The answer must be to promote investment.  As Mr Wolf points out (here but behind the FT paywall), there is a golden opportunity for the government to do so because its borrowing costs are so low.  The trick is finding projects that deliver a convincing financial return; borrowing against such projects does not undermine the country’s finances.  Unfortunately this is easier said than done.  A lot of public projects make extravagant claims about their worth, but are in reality wasteful prestige initiatives – think of the Building Schools for the Future programme.  Or else they turn out to be so badly managed that promised returns are never delivered – think of NHS IT, or Edinburgh trams, or anything undertaken by the Ministry of Defence.

There is no doubt some scope for increasing funding to standard public projects.  But actually what needs to be done is to provide more support for medium sized and small businesses, especially growing ones.  The banks are not stepping up to the plate, demanding ludicrous returns for their efforts.  Surely there is scope for the government to beef up regional development funds and increase funding for institutions such as the Green Investment Bank.  This will not open the floodgates to usher in an era of rapid growth.  But surely it would help.