Opponents of George Osborne’s austerity programme have at last acquired what they had lacked until now: an ally at the top of government. Vince Cable’s powerful intervention in last week’s New Statesman urging the Chancellor to borrow for growth was the first public challenge to his strategy from inside the cabinet. No longer can David Cameron plausibly claim, if he ever could, that “there is no alternative”.
The Prime Minister’s speech on 7 March – the day the Business Secretary’s essay was published – was confirmation that he has little interest in conducting a serious debate about the economy. Those who argue that the government should borrow to invest, he said, “think there’s some magic money tree. Well, let me tell you a plain truth: there isn’t.”
In reality, as Mr Cameron should well know, there is. “Magic money tree” is a reasonable description of the role of the Bank of England, which, at the touch of a button, has created £375bn of new money to buy up government debt and to keep bond yields artificially low. There is no reason why this money, rather than swelling banks’ balance sheets, could not be used to finance government investment or consumer spending.
Besides, the UK is able to borrow at negative real interest, such that any capital investment is likely to prove self-financing. However, John Maynard Keynes’s paradox of thrift remains too paradoxical for the Prime Minister. Mr Cameron and his Lib Dem ally Nick Clegg, the Deputy Prime Minister, ridiculed those who believe that “by borrowing more they would mir - aculously end up borrowing less”. The truth, as Mr Cable wrote in an essay that was widely discussed and read, is that borrowing to invest would not “undermine the central objective of reducing the structural deficit” and could even assist it “by reviving growth”.
In the absence of the latter, the deficit is £5.3bn (5.4 per cent) higher than in the same period last year, even after the Chancellor borrowed £5bn more in 2012 than originally forecast. It is Mr Cameron’s belief that the government can borrow less as the economy shrinks that is fantastical.
After suggesting that the government had no responsibility for the disappearance of growth, the Prime Minister was rebuked by the Office for Budget Responsibility (OBR), the independent body created by Mr Osborne in 2010. The OBR’s Robert Chote wrote to Mr Cameron that “tax increases and spending cuts reduce economic growth in the short term”. This is most obviously true, as Mr Cable noted in his essay, in the case of capital investment, which fell from £48.5bn in 2009- 2010 to £28bn in 2011-2012. The OBR’s multipliers suggest that for every £100 cut from capital spending, GDP is reduced by an equivalent amount. In the past two years, fiscal consolidation is estimated to have depressed output by 1.4 per cent.
The corollary, as Mr Cable and others have recognised, is that through stimulus the government can reverse this trend and increase growth. As well as the Business Secretary, those now calling for a significant rise in capital spending include the IMF, the CBI, the British Chambers of Commerce and the Economist newspaper.
Perhaps emboldened by Mr Cable’s intervention, Liam Fox, the former defence secretary and a powerful right-wing force on the Tory back benches, issued his own challenge to Mr Cameron in a speech on 11 March in which he called for a five year public spending freeze and for the savings to be used to fund aggressive tax cuts and faster deficit reduction, irrespective of the consequences. It was received enthusiastically among the increasingly disaffected Tory right, who yearn for a new champion and for the Prime Minister to create a kind of smallstate, low-tax Randian utopia.
The government is in a bind and rapidly losing popularity. What can be done? After the debacle of last year’s Budget, the Chancellor is inclined towards inaction at the very moment that the need for action is greatest. By refusing to contemplate any big changes to tax or spending policy, he hopes to make a political virtue of his obstinacy: he is indeed not for turning.
The Chancellor is prepared to think imaginatively in one area – for which he is not directly responsible: monetary policy. He is expected to use the Budget to announce a review of the Bank of England’s remit, potentially allowing the incoming governor, Mark Carney, to target growth as well as inflation and to adopt a more flexible approach to the latter. Yet Threadneedle Street cannot be expected to steer the country out of the slump. Mr Osborne’s favoured combination of monetary activism and fiscal conservatism is the economic equivalent of attempting to drive a car with one foot on the accelerator and the other on the brake. To revive demand, rather than merely supply, the two must work in harness.
The coalition cannot be blamed for all of Britain’s economic problems. The continued fragility of the banking sector, the rise in global commodity prices, the shift of power to the east and the eurozone crisis have all constrained growth. But it is precisely for these reasons that wise minds counselled the Chancellor against austerity. Hippocrates’s injunction to “first, do no harm” should have been his watchword. Instead, with the private sector already contracting, Mr Osborne chose to tighten the squeeze. The country continues to pay the price.