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.

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2 Responses to Time for Plan B?

  1. “down right silly.” That seems rather harsh give that my warnings that the UK economy was going to slow again have turned out to be right. I believe I predicted falling output, rising unemployment and falling confidence. I also warned that an expansionary fiscal expansion was actually likely to turn into a contractionary fiscal contraction which I guess is what has occurred

    Even the CBI and the OECD are calling for additional stimulus.

    So how did your predictions work out?

    Danny Blanchflower

    • Matthew says:

      The silliness comment arises to the language that you used on your News Statesman blog, which I have to admit I have only had the patience to read a couple of times (something outrageous about Cameron, I recollect). This seemed to sacrifice playing to the gallery for serious analysis, more or less dismissing supporters of Osborne’s policy as idiots. This does not advance the cause of human understanding at all, in my view. Maybe I picked a bad couple of days.

      As for predictions, well I’m a mere undergraduate economist and haven’t really been publishing them. But I always thought that the scale of the deleveraging was underestimated by most and have not been surprised that the economy is so slow. I haven’t moved my pension fund assets out of index-linked gilts since I moved them there, from equities, back in 2007…when the scale of the crisis first became apparent. So I’m not feeling too bad on the predictions front.

      “Even” the CBI? This organisation jumps on any bandwagon that’s going if it thinks it will help its members’ short-term problem. I haven’t read the OECD’s small print.

      Anyway, it’s not the predictions that are the issue. It’s what the right line of public policy should be.

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