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Osborne's economic strategy remains self-defeating

The Chancellor is wrong to fund £5bn of extra capital spending by squeezing public services.

George Osborne during a visit to the offices of HM Revenue & Customs. Photograph: Getty Images.

George Osborne's decision to increase capital spending by £5bn (to be announced in tomorrow's Autumn Statement) is a belated admission that, in times of stagnation, the state must intervene to stimulate growth. The delusion that the coalition's spending cuts would increase consumer confidence and produce a self-sustaining private-sector-led recovery has been abandoned after Osborne's "expansionary fiscal contraction" turned out to be, well, contractionary. Whisper it, but Keynesianism is back. The £5bn will be spent on "shovel-ready projects", including 100 new free schools and academies, roads, and science and technology programmes.

But rather than taking advantage of the UK's historically low bond yields to borrow for growth (as the IMF and the CBI, among others, have urged the government to do), Osborne will fund the move by squeezing current spending even harder. All government departments, except health, education and international development, will be forced to reduce their budgets by an extra one per cent in 2013-14 and a further two per cent in 2014/15. By reducing demand and leading to thousands of extra job losses, the new cuts will limit the effectiveness of the £5bn stimulus, which, in itself, is inadequate. The FT's economics editor Chris Giles suggests that "on generous assumptions it might increase growth in one year by 0.1 per cent."

Though Osborne will claim otherwise tomorrow, this isn't what's needed to make a real difference at this stage.