23 April 2009

Clear Keynesian water

So what do you do when you’re responsible for a national economy in the worst recession for sixty years? You hold your nerve and have a good look at the options.

You’ve already bailed out the banks to the tune of 3.5% of GDP, to ensure that, unlike 1929, voters don’t lose their savings. You are now stuck with rapidly increasing unemployment, plummeting inflation, a damaged housing market, and loss of public confidence including dreadful opinion polls that indicate you are likely to lose the next election whatever you do.

The options involve the amount you borrow, the amount you tax, and the amount you spend. It’s where economics meets politics and most of us run screaming from the room.

The Chancellor responded with a skilful strategy to begin to restructure the UK economy for the very tough ten years or so ahead of us. Borrowing will remain high, because maintaining public services and investing in the future are more important. Income tax increases were restricted to 50% tax on earnings over £150,000, which for once could be popular. But Alistair Darling did say that further measures were to be considered once recovery sets in, and I would expect these to hit many more of us. In terms of benefits, Labour continued to provide a framework to back people’s own efforts to earn a living and care for their families, rather than make cuts as the Irish government has done. Most impressively, the caring responsibilities of grandparents were recognised. Older people did well out of this Budget, with an increased pensioners' tax allowance, keeping the fuel allowance increase, and larger ISA limits for older people. Again, Darling did not have to do this.

But the most interesting aspects of the Budget came in the spending provisions. First, the emphasis on supporting younger people back into work was welcome. They have had the worst deal in the economic crisis and are quite rightly a priority here. Second, the emphasis on investment to tackle climate change and to kick start a green economy was impressive, although I suspect it doesn’t go far enough. Third, the difficult balancing of ‘efficiency savings’ and new investment in public services: here, growth in overall spending has been reduced but in England the focus remains on health and education, along with a fund for new business development in emerging technologies. The devolved administrations will have their own priorities; Northern Ireland has done much better than we deserve in terms of overall allocation, although what we do with it will be another story and for another post.

I do have some reservations. Predictions of growth in 2010 and 2011 sound over-optimistic. It’s not worth retaining the VAT reduction until the end of the year. References to public sector ‘efficiency savings’ may lead to back door service cuts or quality reductions. Raising the minimum wage now would have helped to set the standard for new lower paid jobs as they come on stream in the next few years. Most importantly, there were no tax cuts for lower income households.

But by and large, the Chancellor did hold his nerve. This Budget sets out Labour’s stall for the next UK general election, and voters in Britain will have the starkest choice to make since 1979. Labour intends to grow us out of recession, thus providing clear Keynesian water between them and the Tories. On Newsnight, Philip Hammond was clear that the Tories would borrow less and cut sooner. The problem for Labour, though, is what to do if the anticipated recovery is slower and more modest than predicted.

It’ll also be interesting to follow the progress of the UK and Irish economies over the next year or so, given the different approaches of the two governments. Cowen’s first two budgets show us what could be in store for the UK under Cameron – a sobering thought.


nick said...

I think the UK government is absolutely right to keep borrowing, maintain public services and avoid tax rises in order to help the worse-off, encourage spending and bring an early economic recovery. I suspect the Irish government's policy of huge tax rises, pension levies and big public spending cuts, squeezing already hard-pressed citizens until the pips squeak, is going to be disastrous.

I also predict the UK economy is going to bounce back a lot quicker than many people think.

Jenny Muir said...

Most economists don't seem to agree with me at all, nor do most of the press, but Will Hutton does so I'm OK...

But I'm not sure I agree that we'll bounce back that fast.

Baino said...

It sounds like we're following their model to a degree. 200 billion has been approved for the government to borrow over coming years, largely for infrastructure, health, education and new technologies and wit but I do worry about paying it back. It took the previous government 10 years to get out of deficit with 100 billion borrowings . . .20 years to clear the debt? We have a labour government that is very popular but they've already spent the entire budget surplus left by the libs. That's a worry for taxpayers and I suspect an indicator for a slower recovery.

Jenny Muir said...

Baino - I agree it's worrying, but I think the alternative would be worse. The real question is going to be how quickly governments are going to want to pay back the debt when the economy starts to pick up, and that will be a balancing act between getting the repayments made and not damping down an increase in consumption. Also I do wonder how much of these borrowings will ever get paid back, or whether some kind of creative accounting will be deployed to get rid of it?