Bill Emmott - International Author & Adviser


Britain doesn´t need shock therapy
The Times - January 4th 2010

Commentary on Britain and its economic prospects has come to resemble tabloid reporting on England´s World Cup prospects. One minute, generally after defeating Andorra or some other giant, we are tipped as likely champions. Next, after losing on penalties to Argentina or Germany, we are written off as having been rubbish all along.

But we are rubbish, aren´t we, in economic terms? Oxford Economics, a consultancy, told us on New Year´s Eve that our national income per head (a rough guide to living standards) is now lower than at the time of the last general election, in 2005; it is now 23 per cent lower than in America and 10 per cent lower than in Germany or France.

The august Financial Times had told us three days earlier that in the decade just ending British growth had, at an annual average of 1.7 per cent, been the slowest since the war, adding to the pre-Christmas cheer provided in the same paper by Max Hastings. He wrote that our "long weekend" was over, that "soon even ostriches will be obliged to notice" that pain is ahead and that "there are fundamental uncertainties about how Britain will earn its living for the rest of the 21st century".

One certainty is that Britain does face "an age of austerity", as Adrian Cooper, the managing director of Oxford Economics, said on December 31. With a budget deficit running at more than 12 per cent of GDP, everyone knows that taxes are going to have to rise and public spending will be cut, by whoever forms the next government. It won´t be pretty.

Yet before we write our position off as hopeless or imagine the austerity as permanent, let´s look at what Mr Cooper said in his consultancy´s equivalent press release on January 7, 2008: then, the Oxford Economics´ headline was that Britain´s GDP per head was set to overtake America´s that year for the first time since the 19th century; "no longer are we the sick man of Europe", he said, thanks to the dramatic change in Britain´s economic performance during the previous 15 years. The football headline writers will be hard-pressed to show a starker volte-face.

Perhaps this just confirms that economists are always wrong. But even if apparent City profits, rising house prices and easy credit-card debts gave us some false confidence, can our economy really have gone from champion to basket case in such a short time? The answer is that it hasn´t. This is a time for realism about what needs to be done, but not defeatism or manic depression.

A fair way to describe the 15 years of uninterrupted economic expansion that Britain enjoyed from 1993 until 2008 is that it was a period of stable, middling growth. Mediocrity would be too negative a word for a time when annual growth in real GDP averaged 2.5-3 per cent, but it gets part of the point: it was steady rather than exciting. But if you sustain such growth rates over a long period you get quite a rise in living standards.

You can´t, and Britain didn´t, sustain such a long expansion on banking, housing and credit cards alone, nor on a bubble. Financial services grew from about 6 to about 8 per cent of GDP: it was important, but not dominant. Other services also mattered: law, chip design, entertainment, telecoms, railways, aviation, advertising and many others. Manufacturing, it is true, declined as a share of this expanding economy: but that still left Britain as the world´s tenth-biggest exporter.

Britain began that 15-year expansion with Ken Clarke entering No 11 Downing Street and having to grapple with a budget deficit of more than 8 per cent of GDP. The situation now is worse than that, admittedly, but that does not make it impossible to deal with.

The rescue effort for the economy in 2008-09 consisted of replacing private spending with public spending, and private debt with the public sort, which essentially meant borrowing from the future. The debt will have to be reduced, and sharply, if Britain is not to be left vulnerable to rising borrowing costs in the future.

As in the 1990s, however, that can be done, and without making economic expansion impossible. This does not, however, mean that it will necessarily be right for an incoming government to emulate the Thatcher-Howe budgets of 1979-81 by making immediate, drastic cuts. The problem today is different: then, it was inflation, which required a recession to solve it. Now, it is deflation, caused by a severe recession.

Unless there are clear signs of revival in private spending, whether corporate or consumer, it would be a mistake to slash and burn straight away, for to do so would send Britain straight back into recession. Then, we would be at a real risk of emulating Japan and entering a long period of stagnation and deflation, which, manufacturing-lovers please note, has not been averted by the fact that a fifth of Japan´s GDP still comes from its factories. Those who fear a collapse in the gilts market if there is no emergency spending-slashing budget should also note the Japanese lesson: even though Japan´s gross public debt is almost 200 per cent of GDP (ours is forecast by the Treasury to peak at 80 per cent in 2015), Japan has had a bull market in government bonds for most of the past 20 years.

What a new government needs to do is promote an economic adjustment that permits us to return to steady, middling growth. Unless the recovery is by then surprisingly strong, it would be better to focus first on structural reforms than on the deficit itself. Restoring equality between capital gains tax and income tax, for example, would be an admirable Lawson-style reform; so would removing the forest of tax breaks and distortions introduced in Budget after Budget by Gordon Brown; probably, VAT could rise to 20 per cent, given that rebalancing from consumption to investment is desirable.

The important point, though, is that restoring the public finances is a five-year task, not a matter of shock therapy. It does mean pain and probably conflict with public-sector workers. But it is an adjustment that Britain, flexible and quite entrepreneurial as it now is, is capable of making. How Britain will earn its living is no more uncertain now than it was a decade or even a century ago. Rather than the new national habit of self-flagellation, I would recommend an older British attitude: the stiff upper lip, combined with a certain quiet confidence.


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