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Nick Clegg’s doublethink on cuts

Clegg admits the cuts are having a “chilling effect” (but supports them anyway).

In today's Financial Times, Nick Clegg makes the startling admission that the coalition's spending cuts are having a "chilling psychological effect" on the public. Clegg's words put him at odds with George Osborne, who has consistently argued that the cuts will increase confidence and that excessive state spending is "crowding out" private investment.

As Anatole Kalestky pointed out in an important column in the Times (£) on Thursday, Osborne's views are based on the theory of Ricardian equivalence (propounded by the economist David Ricardo) – the belief that whether a government finances its spending through borrowing or taxation, the effect on demand is the same.

Kaletsky wrote:

In a paper written in 1820, Ricardo examined whether a government that went to war would be better off collecting £20m in taxes or borrowing the same amount at an interest rate of 5 per cent or £1m a year. "In point of economy, there is no real difference," he concluded. "For £20m in one payment and £1m per annum for ever . . . are precisely of the same value.

Osborne and other anti-Keynesians have since exploited this theory to argue that the public treats government borrowing as "deferred taxation" and, therefore, spends more when the state spends less.

But as Kaletsky notes, this respone ignores Ricardo's explicit rejection of the doctrine. Immediately after the passage on the theoretical equivalence of state borrowing and taxation, he wrote: "But the people who paid the taxes never so estimate them, and therefore do not manage their private affairs accordingly . . . It would be difficult to convince a man possessed of £20,000, or any other sum, that a perpetual payment of £50 per annum was equally burdensome with a single tax of £1,000." In practice, human beings do not see borrowing as being comparable with taxation.

The disastrous final-quarter growth figures proved that the public is reducing, not increasing, its spending in response to the cuts. The widely predicted surge in consumer spending, as shoppers rushed to beat the New Year increase in VAT, never materialised. Yet in spite of all this, Clegg insists that the coalition will maintain its "fiscal stance". With the economy at renewed risk of a double-dip recession, he will have to perform many more intellectual contortions in the months to come.