Author: Alan Shipman

George tells us we are turning the corner: has he done it?

Updated Friday, 20th September 2013
The sudden solidity of UK recovery leaves many economists wondering what went right, writes Alan Shipman.

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In this cartoon, George Osbourne celebrates victory over Ed Balls Britain's economy is growing again. That isn't just a personal triumph for George Osborne, who can now mock his critics for doubting that Coalition policies would achieve a recovery.  It's also a challenge for the numerous economists who said the Chancellor's strategy of rapid budget-deficit reduction would fail, and called for a less austerity-driven ‘Plan B'.

UK national output rose 0.7% across the second quarter, lifting year-on-year growth to 1.5%. The services sector, which comprises almost 80% of gross domestic product, enjoyed its strongest growth for 16 years in August, according to the Chartered Institute of Purchasing and Supply.

With Eurozone export markets recovering, and the new Bank of England governor determined to hold interest rates down until unemployment falls significantly, there is every chance of the growth continuing until 2015, when Osborne's record will be central to his party's quest for a clear parliamentary majority.

The policies that preceded this recovery were repeatedly condemned by leading economists, who jokingly labelled them ‘expansionary contraction.' Osborne claimed that a public-sector shrinkage, made inevitable by his tough spending cuts, would immediately be offset by growth in private-sector output and employment. This would generate additional tax revenue, despite a steady reduction in tax rates – notably of corporation tax, which has dropped to 23% from 26% in 2010, and is due to fall to 20% by 2015. Lower spending and higher revenue would then eliminate the ‘structural' part of the deficit, the part due to previously overgrown  public employment and welfare, as well as the ‘cyclical' part arising from negative growth.

Proponents of ‘Plan B' predicted that public spending cuts would delay rather than accelerate private-sector expansion, by reducing aggregate demand and dampening sales expectations. They argued that slower planned deficit reduction would bring about faster actual reduction, because the economy would avoid another downturn that would erode the government's revenue and raise its spending obligations. After Osborne rejected this softer approach, the economy did indeed fall back into recession.

But he can now blame this on the understated legacy of the 2008-9 credit crunch and the unforeseen severity of the 2009-12 Eurozone downturn – and argue that expansionary fiscal contraction has prevailed, whereas his rivals' more bullish budgeting would have rekindled the debt-driven boom that proved unsustainable in 2008.

Unable to deny its existence, those critics will now have to focus on the sources of recovery, and the way in which present policy avoided the sharp drop in demand that they foresaw. Three questions could still return to haunt the suddenly golden Chancellor: 

Plan B by the back door?

Budget deficits and public borrowing in 2010-15 have turned out to be much wider than the government intended. This is partly due to the growth rate staying well below the Treasury's (and Officer of Budget Responsibility's) expectation. But it also reflects a stepping-up of capital spending – notably on transport projects, housing and school building, which the government initially scaled down. This will enable critics to argue that the corner has been turned because their solutions were belatedly adopted, and that recovery would have come sooner (and the deficit fallen faster) if their capital-project pump had been primed earlier.

Taking too much credit?

While government (central and local) have ratcheted their spending down and are now borrowing less, UK households have actually moved more deeply into debt since 2010. The government has encouraged this by extending its ‘funding for lending' scheme to mortgages, and launching a ‘help to buy' scheme also aimed at house purchase. Policies to restrict benefit entitlement, promote flexible (including zero-hours) employment contracts and freeze public sector pay may also have encouraged private borrowing, by leaving more households unable to pay essential bills without it. The continued growth in UK household borrowing is in contrast to the US and most of Europe, where private-sector debt repayment (‘de-leveraging') has extended to households as well as private companies. It has resulted in many more households being close to the edge than before 2008, according to a recent Money Advice Service Survey. This leaves lingering fears that purchasing power, and house prices, could be punctured anew when interest rates begin to rise, sometime after the next election. 

Unequal shares?

'Expansionary contraction' may have relied on another seeming paradox, ‘impoverishing enrichment' – raising output by squeezing more people into work, and paying them less. This is the result of real wage reductions for existing jobs, as well as movement of workers from higher to lower productivity occupations. It contrasts sharply with the rise in productivity and real incomes that normally accompanies a recovery, and leaves open the question of who will buy the UK's additional output, unless lower costs can trigger an unprecedented export boom. 

Although there is some substance in these fears, none is likely to derail the recovery before voters come to judge the government's first five years. So Osborne's magic looks set to endure until he is re-elected and further promoted, leaving his successor to pick up any post-election pieces. In this respect, George Osborne has gone one better than the last Chancellor to preside over prolonged growth, Gordon Brown. The suspicion that he's secretly deployed the same methods is not one anyone will want to entertain.

This blog post is part of Society Matters. The blog seeks to inform, stimulate and challenge our understanding of this changing world and of our humbling role within it. Find out more about the blog and the team.
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