Show Hide image

Chancellor tries to pull a con trick

George Osborne claims he is trying to avert a “catastrophic loss of confidence” in the economy by im

"Nothing illustrates better the total irresponsibility of the last government's approach than the fact that they kept ratcheting up unaffordable government spending even when the economy was shrinking."

I came across this remark by David Cameron the other day and it made me despair. I hope he knows more about defence and conducting the fight against terrorism than he does about economics, or we are all in big trouble.

Thank goodness the Labour government did ratchet up spending in the face of the worst financial crisis in a hundred years. That is what saved us from entering a terrible economic depression, which is where we would have been if Cameron and George Osborne had been in charge - and they may yet take us there. Moreover, the spending was not unaffordable, as the money has been borrowed at very low rates of interest and invested in keeping activity up and unemployment down.

There is a growing consensus that Osborne's emergency Budget was based on very optimistic forecasts. If that is so, the case for cutting now would be much weakened. Even the ever-honest former chancellor and now Justice Secretary, Kenneth Clarke, conceded on BBC Radio's Any Questions that Britain may well enter a double-dip recession.

J M Keynes's biographer Robert Skidelsky put it very well in an insightful column in the Independent on 25 June. "I do not believe the government should take money out of the economy; it should pump it in," he wrote. "I don't understand how you help growth by reducing spending . . . In a slump, Keynes said, governments should increase, not reduce, their deficits to make up for the fall in private spending. Any attempt by government to balance its budget in a slump would only worsen the slump."

Animal spirits

I am amazed that there appears to be no plan to reverse course if the figures come in much worse than the Office for Budget Responsibility (OBR) is forecasting, as I suspect they will. Economic policy in the UK is being run by a bunch of ideological amateurs who are destined to fail, at enormous cost to the British people.

In his Budget speech, George Osborne said he was acting to prevent "a catastrophic loss of confidence". My concern is that confidence - what Keynes called "animal spirits" - is still fragile and requires nurturing. All this talking down of the British economy by Cameron, Osborne, Nick Clegg and Chris Huhne does not help and may return to haunt them.

In the months leading up to the financial crisis in 2008, UK data on confidence turned well before other more quantitative measures such as output or employment, and was a good predictor of the coming decline, especially in late 2007 and early 2008. This data has the great benefit that it is timely and not subject to revision.

Monthly reports from the Bank of England's regional agents show that, from mid-2007, investment intentions across the UK collapsed, hitting their lowest points in spring 2009. In their latest report, for June 2010, the agents said that investment intentions had picked up, "but remained consistent with a gradual recovery from a low level, rather than a robust pick-up in spending. Intentions continued to be depressed by uncertainty about future demand and by the existing margin of spare capacity."

Business investment in the first quarter of 2010 is estimated to be 6 per cent higher than in the previous quarter. In spite of the quarterly rise, business investment was 11 per cent lower than in the same period in 2009. Investment in private-sector manufacturing was down by 1 per cent on the quarter and by 29 per cent on the corresponding quarter of the previous year. The OBR is forecasting that business investment will grow by 1.3 per cent in 2010, 8.1 per cent in 2011 and nearly 10 per cent a year on average from 2012-2015. It is unclear whether firms will increase investment, but for the government's Budget to succeed, it is vital that they do.


As for consumer confidence, it is again on the wane. The chart (above) plots data from the Nationwide Building Society's consumer confidence and expectations indices, which are available monthly. In a survey, respondents are quizzed on five areas: 1) appraisal of current economic conditions; 2) expectations regarding economic conditions six months hence; 3) appraisal of current employment conditions; 4) expectations regarding employment conditions six months hence; and 5) expectations regarding total family income six months hence.

Catalyst for a fall

The consumer confidence index takes the average of all five questions, while the expectations index averages questions 2, 4 and 5. The chart shows that both indices began to fall from around September 2007 to a low of 44 in the spring of 2009. Both recovered through early 2009, but have since fallen back.

The latest survey, conducted between 19 April and 23 May, covered the period after the general election and the announcement a £6bn spending cut. The consumer confidence index fell sharply by 10 points to 65. The expectations index fell even more, by 12 points to 93. This index has now fallen by 26 points since February.

Commenting on the figures, Nationwide's chief economist, Martin Gahbauer, said: "It is clear to see that the catalyst for the fall in overall confidence has been growing pessimism around the present and future economic situation." Respondents expected the economic climate to worsen, which implies lower consumer spending, which is negative for growth.

Over the following months, I intend to report on the various data series I will be watching to help evaluate the success (or not) of the coalition government's rash economic gamble. Next up: developments in the labour market.

David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and visiting 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 

This article first appeared in the 05 July 2010 issue of the New Statesman, The cult of the generals