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The Tories’ volcano economics

Gardeners understand that a late frost can kill off early growth. It is the same in the first days o

I arrived in London just ahead of the volcanic ash plume and spent some of that week helping to organise yet another letter denouncing as "rash" and "destabilising" George "Slasher" Osborne's plan to scythe public spending. It was signed by 77 distinguished economists, including two Nobel prize winners, Bob Solow and Jim Mirrlees. We argued that efficiency savings are "just cuts by another name".

That a gaggle of business CEOs who are Tory supporters wrote to say that they supported Slasher was hardly news, especially as it is in their own self-interest to oppose any rise in National Insurance. As far as I can tell, none of them has any credentials in the messy business of conducting macro-economic policy.

Unsurprisingly, the car industry supported the cash for bangers programme, farmers like milk subsidies and turkeys don't vote for Christmas. Most telling is that the Tories have been unable to find a single eminent economist to support their position on National Insurance.

Risky business

As Robert Skidelsky, my friend and Keynes's biographer, told the Financial Times, there is still a danger of another recession. "All we are doing here is trying to buy time. I could make a very strong case for not making any commitments to deficit reductions until there was clearer evidence of a substantial bounce-back."

Writing on 14 April in the Financial Times, the paper's economics editor, Chris Giles, reported on some useful detective work he had conducted on the supposed effect of the National Insurance increase planned for 2011. He calculated that the research done by Slasher's main economic adviser threw into question the Conservatives' claims that the proposed Labour rises in National Insurance contributions would destroy upwards of 57,000 jobs.

In a 2007 article in the Economic Journal, three economists, including Rupert Harrison, now adviser to Slasher, estimated the effect of taxes on unemployment. Giles applied their equations to Labour's proposed NI rise and found that it produced a forecast unemployment increase of 23,000. This figure is far fewer than the 57,000 jobs that the Conservative manifesto claimed would be lost in small and medium-sized companies alone as a result of Labour's proposed increase.

The Lib Dem leader, Nick Clegg, may well be right when he warned, in a recent interview with the Observer, that he fears "serious social strife" would break out if a government that had achieved limited support at the election on 6 May raised taxes, laid off public-sector workers and froze wages.

There have been some important economic data releases in Britain over the past weeks. The mortgage-lending numbers were pretty weak and inflation has increased a little. But this increase is only temporary, contrary to ill-informed arguments. In fact, inflation is about to start on its inexorable, downward path into negative territory and deflation.

Deflation would be disastrous for the British economy. (Soon, there will also be releases on the public finances, which could well be better than expected.) The labour market news was rather mixed. The big headline on 21 April was that the number of people claiming unemployment benefit fell by 33,000. But the number of ILO unemployed (the broader, standardised count across countries), some of whom are not eligible for benefits, increased during the three months to February by 43,000 to 2.5 million.

This meant that the unemployment rate jumped from 7.8 per cent to 8 per cent and the total is now at its highest since 1994. Most worryingly, the duration of unemployment spells has started to rise; people are not flowing out of unemployment. The proportion of the unemployed who have been without work for at least a year is 29 per cent compared with 22.8 per cent a year ago. There is very little consistent evidence of much of a bounce-back in the labour market. Spells of unemployment are getting longer.

The most important statistical release - the first-quarter GDP output figures for 2010 - was due out on 23 April, after we went to press. Most forecasters, including the OECD, were suggesting that quarter-to-quarter growth would be positive, at about 0.4 per cent, following on from growth of 0.4 per cent for the fourth quarter of 2009. This would give a boost to Gordon Brown and vindicate his economic policies. However, any growth much larger than 0.4 per cent could be a problem for Labour: it would weaken Brown's claim that Tory cuts would threaten recovery.

From the ashes

Meanwhile, that damn Eyjafjallajökull volcano in Iceland has been costing the airlines and our airports many millions in lost revenue. The share prices of Lufthansa, British Airways, Air Berlin, Air France-KLM, Iberia and Ryanair all fell as flights were cancelled throughout Europe.

Experts fear the eruption might spread to Katla, a neighbouring volcano that is ten times larger. Katla is supposed to erupt every 40 to 80 years; the last major eruption was in 1918. When Eyjafjallajökull erupted in 1821, it spread to Katla.

he Icelandic volcano is a useful illustration of how mistaken it is to declare in advance what your economic strategy would be in the depths of a once-in-a-century recession. Nobody expected that Heathrow airport would be closed because of an ash cloud. What if the eruption went on for weeks, or months? That would be bad for commerce and might even push the economy into a double-dip recession.

How does Slasher possibly know this will not happen? He doesn't. Gardeners understand that a late frost can kill off early growth. It is the same in the first days of an economic upturn, which can easily be blown off course. Keep your plants in at night until it warms up and defer spending cuts.
In response to a journalist who asked what was most likely to blow governments off course, Harold Macmillan replied: "Events, dear boy, events."

Amazingly, an erupting Icelandic volcano could stifle the recovery. It is a jolly good idea to buy some time right now and see how things develop. And I may not get home to America this week. At least the ash clouds are now clearing and the airports are open . . .


David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and professor at the University of Stirling.

David Blanchflower is professor of economics at Dartmouth College, New Hampshire, and a former member of the Bank of England's Monetary Policy Committee