This week, U.K. Chancellor of the Exchequer George Osborne will unveil his annual budget. Rarely has the country so badly needed bold new policies to generate growth.
Osborne, unfortunately, is unlikely to deliver. Just a week ago, his boss, Prime Minister David Cameron, declared that “there is no alternative” to the government’s austerity policies, echoing Margaret Thatcher’s steely use of the “TINA” phrase ― known ever since in Britain by its acronym. Thatcher was the “lady not for turning,” and Cameron wants to be just as tough.
Cameron is mistaken about TINA. Not because Thatcher was wrong in the 1980s (she was right), or because the U.K. doesn’t need to bring down its budget deficit of 6 percent of gross domestic product or its public-debt ratio of 89 percent of GDP (it does). The question is how to do it.
The current policies aren’t working. The U.K. economy remains smaller than it was before the collapse of Lehman Brothers Holdings Inc. in 2008, and real incomes are shrinking. Too much austerity too soon is a critical reason that the recovery has been so slow ― and thus why the debt ratio keeps rising. The government is overshooting its deficit-reduction targets because of falling tax receipts.
And the economic news this week was again dire: manufacturing output fell by 1.5 percent in January, suggesting a third dip into recession is on the way.
Osborne and Cameron insist they can’t do anything to relax fiscal policy because it would alarm financial markets. They cite the move last month by Moody’s Investors Service to cut the U.K. sovereign debt rating to less than “Aaa.” If the markets lose faith, they say, debt-service costs would soar and the country would be on a path to insolvency. The government’s cost of borrowing has already crept up a little, to 2 percent.
These fears aren’t groundless, but the government is drawing the wrong conclusion. The too-tight squeeze on fiscal policy is self-defeating. If the cycle of stagnation and austerity continues, the debt outlook will continue to worsen and markets will have more reason to worry, not less. (Moody’s emphasized the economy’s slow growth in announcing its rating change.)
Short-term easing would make the longer-term commitment to control public debt more credible ― so long as the plans are heavily front-loaded and concentrate on supporting growth.
The government has already identified the right thing to focus on: infrastructure. There’s an enormous backlog of worthwhile projects; the short-term boost that construction delivers to the wider economy for every pound spent is high (the Confederation of British Industry says the so-called multiplier is almost 3); and well-chosen infrastructure supports long-term growth.
Yet the cranes aren’t moving. That’s because most of the hundreds of projects on the government’s wish list depend on private funding, which hasn’t materialized. Planning delays and an emptied project pipeline due to drastic capital-spending cuts two years ago have also contributed. Public money and political will could solve these problems.
The harder question is how much public money. The CBI has recommended 1.25 billion pounds ($1.86 billion) for construction. That’s far too little. Ernst & Young’s Item Club, which uses the U.K. Treasury’s model to produce economic forecasts, has suggested $21 billion. The National Institute of Economic and Social Research has called for infrastructure spending of up to $57 billion, arguing that with borrowing costs still at historic lows this is affordable.
Economists we spoke to at London’s commercial banks put the safe number for new government borrowing at as much as $15 billion, which would add less than a percentage point to the current debt ratio. That looks timid to us ― but bear in mind that $15 billion of borrowing could support a bigger sum for infrastructure if public spending that doesn’t support growth as strongly were cut back.
The more stimulus spending is concentrated on short-term investment, the more clearly it is separated from the regular budget, and the more it is supported by, for instance, issuing government-guaranteed infrastructure bonds, the less investors will react against it.
Osborne seems likely to choose something like the minimalist CBI proposal, covering the cost with more tax increases and spending cuts. That would keep the burden of reviving the economy on the Bank of England and its next governor, Mark Carney. The bank will presumably do its best, but monetary policy has its limits when interest rates are already so low. We think stronger fiscal action is needed ― certainly no less than the $21 billion boost the Item Club proposed.
Cameron and Osborne have made the politics of altering course much harder by insisting on talking tough. For the economy’s sake ― and if the Tories have any interest in winning the next election ― they need to put TINA to rest.