...a blog by Richard Flowers

Thursday, April 26, 2012

Day 4133: Driving into a Hole


Top story on the BBC: an unnamed driver – known only as "Master Gideon" – has crashed his car into the Paris Metro. Apparently he misread the signs.

OK, look it's NO GOOD pretending this is good news. We're in a recession again.

The difference between the expected +0.1% growth and the surprise -0.2% contraction is pretty tiny. But that's just saying that the economy would have been pretty dire even if we HAD avoided a second recession on a technicality.

This is NOT the outcome we wanted. We should admit that and ask what we could do better.

The Chancer of the Exchequer, Master Gideon Oboe – henceforth to be known as the Double-Dipsh— no, I can't say that! – has already had a BAD MONTH because of the Budget, because actually it DID slap more taxes on the rich and the very, very rich and they've been finding all sorts of ways to whinge about it.

It's funny how we're told to cut less and tax a little more right up to the point where we DO that and then it's pasty-tax this and conservatory-tax that and cathedral-tax the other.

(And it's REALLY helpful when you can get CHARITIES to front up your demands for tax loopholes. Of course, some people might say that if you need a tax break in order to give money to charity, you don't deserve to call yourself a philanthropist. Even if the charity in question is the Birmingham Opera Company, who I am sure bring great joy to the least well-off through their Pas des Deux-es.

(Look, with charity donations, like PENSION CONTRIBUTIONS, there's a case for saying that they come out of your BEFORE-TAX income, fair enough. So if I've been persuaded by the Party that the amount you put in your pension should have a cap, then it seems only CONSISTENT that they should say the same for the charity giving.)

In part the badness of the news is PSYCHOLOGICAL: just the WORD "recession" is enough to dent confidence and slow our chances of growth and recovery.

OF COURSE it hurts POLITICALLY. It lets Hard Labour weep their crocodile tears and crow about "wrong choices".

But we should not let that put us off taking a SERIOUS look at our choices and reassessing whether they ARE bad or not.

And you KNOW how much I HATE it when Ms Nadine "Mad Nad" Dories might have a POINT.

But "remorse, contrition and compassion" are EXACTLY the qualities that we should be showing. They are what I had HOPED would make the difference between this administration and the governments of Queen Maggie and Mr Major-Minor.

Why isn't it working?

The predictions of growth that have repeatedly proved so over-optimistic are based on the way that the economy – nationally and globally – has bounced back from previous recent recessions (1972, 1980, 1991, 2001). But in some ways, the REASON for those bounce-backs was CAUSE of this recession: we were pouring on more of the old problem, racking up ever-more DEBT.

The Bank of England relaxed lending laws at the start of the Seventies, triggering a house price boom that helped us over the Oil Shock; our own North Sea Oil, i.e. the flogging off a previously-undiscovered asset, reducing the Nation's net savings, rescued us from the early-Eighties recession; leaving the EMU and the subsequent devaluation and inflation lifted us out of the Nineties property crash, again at the expense of a lot of National wealth, and of course a huge burst of cheap borrowing forestalled the collapse in the early Two-Thousands.

This time around, it's that very borrowing that has finally caught up with us and CAUSED the crash. We can't at the same time take the action to stop it happening again AND let it happen again to get us out of the hole.

Essentially, we've been storing this cataclysm up for four decades, and the models really aren't ready for it.

Another big drag on growth is the renewed (or never-went-away) CREDIT CRUNCH.

I've said before, many times, how if you lend more money it has a magical multiplying effect that boosts economic growth; and that if you reduce lending then it reverses the process, sucking growth right back out again.

The banks are having to build up much bigger reserves against losses to meet the new regulations that the Coalition have put on them. In simple terms, this means they need more money IN and not as much OUT.

It's why, for example, the Halifax-that-we-own have raised their mortgage interest rate even though the base rate remains frozen at an all-time low. They're gouging an extra margin from borrowers to build their own balance sheet. But at the same time cutting people's spending power, taking money AWAY from activity that could help growth.

It's the same problem that we had with the VAT rise last year – money is burnt up in interest (or tax) instead of being spent on making things.

Thirdly, there is the simple factor of TIME. Almost ALL of the levers that Gideon the Chancer can pull take a VERY long time to affect the economy. There's a BIG rise in the personal allowance coming in – it's been announced for ages but it's only going to go into your pay packet this month. Too late for the first quarter growth figures. The EVEN BIGGER tax cut announced in this year's budget won't get to you until NEXT year.

That VAT rise last year had a big impact, pumping up inflation, and it's only a year later that the inflation figure is starting to come down (subject to the ongoing energy crisis and soaring food prices). Once you've done something like that it's TOO LATE to change your mind. Sure, you can chop and change the VAT rate all the time, as Labour propose, but that causes no end of problems and costs for businesses who have to reprint all their price lists and reprogram all their accounting software.

In a way, it ought to be impossible to blame the Coalition… YET. Because the cuts have barely started. We hardly cut at all in 2010, and 2011 was merely the beginning. Except for the VAT rise, really, the impact has not yet arrived.

The most terrifying aspect of this though is that most of the cuts are STILL TO COME. The plan is, as it always was, to keep spending the SAME in cash, and allow inflation to do all the dirty work. Then any real growth above inflation would give the Coalition more room to manoeuver, slackening off on the spending controls, reducing the bite of the extra taxes. But the growth hasn't arrived. So the screws continue to tighten.

Could Hard Labour have been RIGHT?

Well, there IS always that possibility. But I still don't think so.

Hard Labour's solution was – and still is – more stimulus, paid for by more borrowing, to try and kick-start the economy. They'll point to Americaland where President Barry O DID do more stimulus (spending coupled with a package of tax cuts) and the outcome appears to be an economy that might just come good in time for his November re-election.

(Of course that is SIMPLISTIC – the US economy has a different economic mix, with more manufacturing and much less finance and they are much less closely tied to Europe, but on the other fluffy foot have much, much worse borrowing to start with – but it's a crude enough comparison to be worth considering.)

The American example shows that more stimulus COULD have worked.

What it doesn't show is that it WOULD have worked.

If a patient has a massive heart attack, you can get them back on their feet with a massive injection of adrenaline.

They'll bounce up and run around for a bit at first, but of course IT WILL KILL THEM.

And in a lot of ways this is exactly what Mr Alistair Dalek DID do with his VAT cut and Quantum of Easing. He injected the economy with a massive dose of cheap money and the so-called growth was bought, almost literally pound for pound, by borrowing it from the future.

Hard Labour's MASSIVE ECONOMIC GAMBLE was – or would have been – to KEEP pumping borrowed growth into the economy in the hope that a genuine recovery would come along in time to save them.

Essentially, keep the patient running around and keep your fingers crossed that their heart starts again on its own before they DIE.

The PROBLEM with this approach – and it's a FUNDAMENTAL problem – is that all you've done (so far) is create a massive PONZI scheme: you are generating growth at the front door but only by pumping in borrowed money at the back door.

What is ABSOLUTELY ESSENTIAL is that once you HAVE got an economy that looks like it's growing is THEN you do the HARD WORK to fix the broken bits of your system: cut your spending; run a huge budget surplus to repay your borrowing; rebalance your economy in favour of wealth-generating and away from government spending.

And based on their history there is NO EVIDENCE that Hard Labour would be willing to DO that work. They would just repeat the DISASTER of their last government and fund a spending binge on the never-never.

(There's also a secondary problem with Labour's methods – to be effective, you need to give your stimulus of borrowed money to the PRIVATE SECTOR, to manufacturing, construction, mining or farming – including wind farming. Basically, things that GENERATE more cash than you put in. It's called INVESTMENT. The evidence shows that what Hard Labour's SPIN MACHINE calls "investment" actually means spending the money on more public sector workers instead. That may result in a better society in the long run, but it doesn't solve the immediate problem and arguably makes it worse in the short term by adding more costs to other already-hard-pressed workers.)

Whether the gamble succeeds or fails depends on how long people can be persuaded to keep lending you the money.

If you're lucky then you get away with it. Enough growth in genuine economic activity – not just recirculating government money – and you can pay for the extra borrowing to cover you through the "actually fixing the economy" phase.

But if you're unlucky, if the manufacturing and service sectors don't come up with the goods before it becomes too expensive for you to carry on borrowing, then never mind GREECE... the next stop for the economy is YEMEN.

On coming into power, in the climate of turmoil on the money markets, on seeing the Treasury's books, on receiving the infamous "there's no money left" note from Liam Byrne, with the spectre of a potential Greek collapse hanging over us... all of these factors persuaded the incoming Coalition that the time before the borrowing dried up was LESS rather than MORE, and that the chances of the GAMBLE paying off were not worth the risk.

Does that mean that we missed the chance of a short cut out of the pain of a trashed economy?

Yes, it does.

But we ALSO avoided the downside risk of a toxic combination of spiralling national debt, escalating interest rates, out-of-control inflation and STILL no growth – the kind of mix that's destroying the Eurozone at the moment.

This is BAD but it's a LONG, LONG way from as bad as it could be.

The government managed to hit its annual borrowing target – in part thanks to that VAT rise.

Yes we "only" added a hundred and twenty six billion squids to the national debt last year. But that's eleven billion squids fewer than in the year before, despite rising inflation. The gap is closing.

And the pound continues to STRENGTHEN against the DOLLAR and the EURO, showing that the markets believe our economy is SAFER and STRONGER than either the Americaland or the Euroland economies, in spite of growth over there while we're still bouncing along the fluffy bottom. People want to invest their money HERE, and that's a good thing.

What should we DO about it?

Well step one is DON'T PANIC!

Own up to the fact we've NOT solved the problems of the economy yet. They were pretty massive but we thought we could do it. We SAID we could do it. But (at least so far) we HAVEN'T.

But that's NOT a reason to flail about wildly adopting "Plan B", "Plan C" or "Plan 9 from Outer Spads" at random.

We should look at what we ARE doing. Does it look RIGHT? If not, can we fix that? Who is being hit hardest? Is that fair? Can they take the cost? Can we give more help to those in need?

In this immediate set of figures, it appears that the driver of this contraction is the construction industry. And this is ANNOYING because it's one place where the government COULD reasonably borrow to invest: buying new home building and road and rail infrastructure NOW helps keep builders in employment AND prepares the way for when the recovery comes. And the assets that they build can return an "economic rent" – if they're houses a literal rent – that covers the cost of borrowing so it DOESN'T damage the economy.

And to be fair the Coalition ARE doing SOME of this. But clearly not enough and/or not quickly enough.

Planning laws and general NIMBY-ism are a real brake on bringing forward these projects. Obviously High Speed 2 is going to take a geological aeon before it breaks ground, but just think of all the objections to new windmills or new housing estates, too. Having said that, I bet you most MPs could name one or two "off the shelf" projects in their constituency just waiting for funding – that's a place we should be looking to nudge a bit harder.

Less construction isn't the whole of the story. There's just not any growth in any other areas to make up for it either. Remember Mr Dr Vince's leaked letter – we need to sharpen our strategy for growth, boost investment and back Britain.

Unclenching the credit crunch is going to be necessary if not vital. Captain Clegg made a speech about access to finance today.

But we also need a revival of OPTIMISM.

It's not all bad news. The rise in commodity prices means that some things that were not economically viable before now look profitable. That's what happened with North Sea Oil in the Seventies. This provides new OPPORTUNITIES. Some of them are GOOD (like mining space asteroids); some of them are, er, NOT SO GOOD (like Fracking Blackpool).

But what is KEY is that people are now starting to CONSIDER these opportunities.

People are willing to make PLANS – however outrageous or barmy they may seem.

THAT is what's needed for recovery, the start of the upswing, a sign of hope.


teekblog said...

Interesting analysis as ever.

I wonder what thoughts you have on Social Liberal Forum's Plan C - which advocates many policies that would kick-start growth without returning to the unsustainable debt-fuelled days gone by - you can find a copy at



Millennium Dome said...

Thank you :)

I'm certainly happy to consider the SLF proposals and I'll read the pamphlet. Congratulations - you made a sale ;)

But shifting economic policy is going to be difficult when it means getting it past the Tories and the markets.

That's why I advise a strategy of recognition, review and repair - recognise that we have not fixed the damaged economy yet, review what we are doing with a view to minimising harm, repair (if we can) any areas we can see we're getting badly wrong.

I want a government that only does bad things because it HAS to, and then tries to do the LEAST bad!

teekblog said...

KERCHIN.... I mean, thanks!

your recognition review repair approach is an excellent way of looking at things, a really nice insight that would truly bring about an era of evidence-based policy - if only government actually worked like that :-)

as for getting things past the Tories and markets - I naively think that's simply (or rather, not so simply) a case of making the case for reform strongly enough and backing it up with, well, recognition review and repair...!