Osborne will not and should not change course

George OSborne: not for turning. (Photo: Getty)

Over the past week, the background noise of the usual suspects calling for a “Plan B” – repeated so often and so monotonously that there should be some “white noise” device that can blot it out – has received apparent support from some unlikely sources.  Bill Gross, chairman of Pimco has been widely quoted calling for a “course correction” – though fewer have noted that he said explicitly that he was not looking for a U-turn but instead a mild adjustment.  And he didn’t set out what that mild adjustment might actually be – temporary tax cuts, perhaps?  The Wall Street Journal has proclaimed that “Osborne Can’t Avoid a Change of Course“.

Osborne however, takes the opposite view, including today with his speech to the Lloyds of London dinner.  He says that the Coalition deficit reduction plan was made for good times as well as bad, and points out that it was set at a time and in a form of the government’s own choosing, last summer, rather than being forced upon it by the markets as plans in Italy, France, Spain and Greece have been this summer.  He alluded to the downgrade in the UK’s growth forecasts that the Office for Budget Responsibility has already signalled, but claims that will not force him to change direction.

He’s right, by and large.  It is of huge benefit to Britain that we have set about a credible deficit reduction plan in advance, and as a consequence the amount and pace of the cuts are less than would have been necessary had we taken the advice of those that urged against reducing the deficit.  If the government had listened to Ed Balls and his supporters, the likely consequence would have been faster and deeper cuts to the deficit, forced upon us by markets in a panic.  Deficit cuts forced on us under those circumstances would probably also have involved larger tax rises.  Since tax rises tend to damage growth, at least in the short term – the tax rises in the Coalition’s plan are politically necessary, to give us a sense that we are “all in this together”, not economically desirable – if we had been forced into precipitate tax rises under market pressure, the likely consequence would have been recession.  Also, of course, one of the manifestations of the market losing confidence in the British government would have been a large rise in gilt yields.  That would have made investment more expensive, damaging growth even further.

The government’s path is the pro-growth one.  Spending is cut, which will raise the long-term growth rate of the economy, allowing consumers to pay their debts, reducing the risk of banking collapse and allowing more spending in the short term.  The deficit is cut, reducing the risk of sudden large rises in interest rates and precipitate tax rises forced by market pressure.

Just because Osborne’s plan is pro-growth doesn’t, of course, mean that growth will be rapid.  It just means we get more growth (or less recession) than we would have done under the Ed Balls course.  The economy was in a dire state by 2010.  As pointed out in a paper released by the Bank of International Settlements last week, by 2010 Britain’s debt levels on all metrics – government debt; corporate sector debt; household debt – were above the levels expected to damage growth over the medium term.  In addition, government spending had risen from just over two fifths of the economy only three years before to around half the economy – again, damaging growth.  Public sector productivity growth has been dire – indeed, negative on some metrics, dragging the economy down.  The demographic challenges of an ageing population had been ignored for far too long with retirement ages raised far too slowly, meaning that the economy was projected to have an ever-smaller proportion working carrying the load of an every-larger proportion of retirees.

Such challenges have meant that the sustainable growth rate of the economy – more traditionally thought of as around 2.5 percent for the UK – may have fallen to perhaps only 1.7 percent.  The government planned its deficit reduction programme on the basis that the sustainable growth rate had fallen only a little – to 2.1-2.35 percent out to 2015/16.  That could well be optimistic.  If it is, then Osborne won’t meet his deficit reduction targets as hoped.

But how would this be helped by a Plan B?  Plan B is to deny that the economy can only grow slower.  It is to pretend that all we have are some temporary problems that we can thrust through by borrowing which can then be paid back from faster growth later.  But if the real problem with meeting the growth and deficit-reduction targets is that the economy just can’t grow as fast as the government hopes over the medium-term, then borrowing even more will make that worse, not better.  More borrowing will increase the structural deficit further, and will damage growth more – even if it doesn’t lead to the sort of crisis seen elsewhere.

Osborne should stick to his course.  His only correction should be to try to get there faster, if he can.  That is to say, if the economy slows further, we should not slow the pace of or reduce the depth of spending cuts.  Instead, we should cut more and cut faster.

Cut early; cut deep.  That is the way to maintain market confidence, it is the way for the Coalition to deliver on its promises, and it is the way to deliver growth.