Why we must keep on spending

The government must resist the pressure to cut borrowing.
What is needed at the Budget is another

The UK economy today is not where Alistair Darling hoped it would be when he gave his pre-Budget report in November. It is closer to where he feared it might be when he warned last August that this downturn could turn out to be the worst for at least 60 years. The economy is contracting faster than the Treasury expected, which is why a strengthened fiscal stimulus would be the right response in the 22 April Budget.

Had Darling known last autumn what we know now, he would, I am confident, have planned a bigger overall boost to promote recovery in the short term, albeit one with targeted initiatives. Such a stimulus would involve reshaping the subsequent trajectory of government spending and taxation to bring the public finances back into shape in the medium term. There is no escaping the need for fiscal discipline once the immediate danger of depression has been dealt with. But cutting public spending now to reduce government borrowing, as David Cameron proposes, would invite disaster. Scaling back our public investment plans now to please the governor of the Bank of England would be to signal timidity when the situation calls for boldness.

The world allowed the 1929-30 financial crisis to turn into economic catastrophe, because the authorities at the time clung to incorrect assumptions about what was possible. They became the prisoner of conventional wisdom and resisted the advice of those, like Keynes, who argued that extraordinary circumstances warrant extraordinary measures. We must

not fall into a similar trap today. Rather, we should remember J K Galbraith’s advice that “the world owes much to men and women who are undiscouraged by the voices of realism”.

The pre-Budget report was bold in proposing a two-year, £20bn fiscal stimulus. That package has not shrunk in my estimation. What has changed, and for the worse, is our grasp of the true size of the challenge we face, and the threat to the economy stemming from the global financial crisis. Meeting that challenge will entail making two changes to the pre-Budget package. First, rejecting calls for cuts and instead strengthening public investment plans announced in November, as well as tackling youth unemployment in particular. Second, moving towards a progressive tax system by cutting income tax and National Insurance on lower-income households, so that fairness plays a real part in future recovery.

It is the background to the Budget that makes me so concerned to maintain momentum towards recovery with a further fiscal stimulus. Despite the positive outcome of the G20 summit, worrying but credible comparisons are being drawn between current economic conditions and the start of the 1930s Great Depression. World trade is sinking faster in this recession than it did in the opening months of the 1930s slide into slump.

In the world’s leading economy, the United States, industrial production in the first year of this recession has fallen about half as fast as at the onset of the 1930s Depression: not yet the disaster that engulfed the world back then, but a cause for grave concern all the same. Like Japan, Germany and France, Britain is also experiencing an industrial slump, with the percentage fall in UK industrial production already into double digits.

For a long time, a lone voice on the Bank of England’s Monetary Policy Committee warning of the danger of recession and calling for early interest-rate cuts was that of David Blanchflower. He has been proved consistently correct in his reading of the economy. His most recent warning is that, without strong fiscal action, today’s downturn could fall further and last longer than any recent recession, causing UK unemployment to soar towards four million in 2010 and condemning a generation of Britain’s young workers to years on the dole.

The lesson from the 1930s Depression is that prompt and persistent attacks on the problem are what is required to stop a slide into slump. Governments must be willing to reinforce their opening shots with unconventional measures if orthodox approaches, such as cuts in short-term interest rates, prove ineffective.

Franklin D Roosevelt’s 1933 inauguration speech is remembered today for a ringing phrase about fear. But what lifted American hopes at the time was his clear commitment to a vigorous, extended programme of action. Popular history has focused on the initial stimulus from New Deal public works projects that helped trigger the turnaround which began in 1933. The New Deal may have been the spark that lit a fire,

but, according to the chair of Barack Obama’s Council of Economic Advisers, Christina Romer, more important were the bank reforms and monetary measures that fuelled expansion over the next four years. Persistence was what paid off, through fiscal initiatives coupled with monetary growth.

FDR responded to pressure, similar to that heard today, to temper the New Deal by cutting back government borrowing in the mid-1930s, only to see the dole queues lengthen again in 1936-37 as the US economy reversed course and slid backwards. It would be tragic for the UK today to risk snuffing out recovery before it had even taken hold by reining back prematurely on public investment programmes.

It would be fanciful to assume we are likely to solve today’s economic problem at one fell swoop with a single fiscal stimulus or a single rescue package. Yet the Tories have sought to raise such false expectations. They portray any government initiative as proof of past failure and dismiss programmes announced in January 2009 as flops by St David’s Day. A Tory party which used to champion monetary policy that works with long and variable time lags is poorly placed to demand instant results. George Osborne cannot see a balanced package without detecting a mixed message in it.

More serious is Cameron’s anti-Keynesian stance. His opposition to government borrowing in the face of the worst recession for 70 years sets him where he always felt he belonged: in a class apart. Across the world, governments of all political persuasions have responded to the recession by applying Keynesian remedies and boosting government borrowing – raising total spending by increasing public expenditure, cutting taxes and interest rates to encourage consumer spending and spur on business investment, and providing funds to help industry overcome a squeeze on its working capital. Higher government borrowing is inescapable and a vital part of effective economic policy in today’s critical conditions.

Short-term interest rates in the UK are now virtually zero. They can go no lower. Cameron has failed to learn from Keynes’s analysis of what can happen if an economy gets caught in this liquidity trap. Without other measures, such as a fiscal stimulus raising government borrowing, the economy can remain stuck, with unemployment stubbornly high, industrial capacity hugely underused and workers, in Galbraith’s phrase, abundant, redundant and poor.

Cameron called recently for a new, more popular capitalism. Nigel Lawson also promised popular capitalism in 1986 with his failed plan to turn Britain into a nation of small shareholders. Many people who listened to the Tories then must regret it now.

As yet, few seem fully to appreciate that, by opposing Keynesian policies today, Cameron would condemn Britain to dogmatic cuts in public spending and years of stagnation. That is what dropping his commitment to “sharing the proceeds of growth” in favour of giving “priority to debt reduction” really means. Slashing public services could even boost government borrowing by causing the economy to shrink even further, while hitting hard those most in need of state support. Cameron’s priorities might promise “capitalism with a conscience”, as he pledged at the World Economic Forum in Davos, but it would be a guilty conscience.

Simply waiting for market forces to ignite an economic revival is like waiting for spontaneous combustion. Patience may be a virtue but it is not what you need to stop a slide into slump. When the fire has gone out in the furnace of the economy, what is required is a spark and a steady supply of fuel to get things moving again. Only governments can boost spending on the scale required to revive the economy.

As ever, why look in the crystal ball to assess calls for cuts in government borrowing during the worst economic downturn since the 1930s, when we can simply read the history books? Geoffrey Howe’s 1981 Budget cut borrowing by 2 per cent of GDP. The economy soured and unemployment soared – to more than three million, by 1983, where it stayed for four years. The government of Japan responded to the threat of

recession in the 1990s by taking action that was too little too late. By doing so, it allowed business and consumer confidence to drop so much that even a series of recovery packages was woefully slow to take effect.

The last thing Britain can afford is to take our foot off the fiscal pedal and go easy on the gas. No one wants a reckless Budget. Darling has rightly and repeatedly insisted that we will get through this. Pushing ahead with public investment will help see that we do by keeping up the pace towards recovery.

Peter Hain MP is a former cabinet minister