History teaches us that cuts are the right choice
Published 26/10/2010 | 10:42
Last week was, for obvious reasons, a troubling week, and that is true whatever your judgment on the spending cuts. So it is helpful to step back and put a bit of perspective on all this.
The best starting point is to ask where we are in the world recovery. The point that the emerging world has continued to grow and that the recession has been a developed-world phenomenon has been made so often that there is no reason to labour it here.
Come back to the old developed world and there still seems to be reasonable growth, but it is uneven. The US economy seems to be faltering but the German economy is still growing strongly and the rest of Europe, bar the most indebted fringe countries, is not doing too badly either. This has led to a different perception of what should happen to policy. In the US there is a strong call for more quantitative easing, while in Europe the prevailing view is that if the countries hang on in there it will all be all right.
So the US will try to give another monetary boost to the economy in the coming weeks. There are a number of justifications for this. One is that it will make funding the fiscal deficit easier and cheaper and will nudge down the dollar, thereby boosting US competitiveness. Another and slightly different justification is that asset prices in the US, particularly property prices, had apparently bottomed out but may be falling back again. Until there is a floor under property it is going to be hard to rebuild consumer confidence.
By contrast, the growth in Germany is impressive. Business confidence jumped in October and is close to its peak at the top of the last boom in 2006. Unemployment has been falling and employment rising. Consensus forecasts for GDP growth this year are around 3.3%. Retailers are at their most optimistic since the post-unification boom in the early 1990s. As a result, it seems likely that Germany will again be the locomotive for the eurozone, pulling its neighbours with it.
Recovery in the developed world is slowing a little but is still positive. This has relevance to us. As spending is cut the private sector must take up the slack, in terms of employment and output.
But — and this is a real concern — during the previous periods of fiscal squeeze the rest of the world economy was growing strongly, so it was easier for the private sector to take advantage. Now, given that governments in the developed world are cutting deficits, that prospect is not so certain.
There are two arguments against this. One is the oft-made one that the alternative would be worse, that the country would be faced with a collective loss of confidence at home and abroad.
The other is that we are an open, medium-sized economy and cannot but benefit from the global cycle.
Experience from the 1930s onwards tells us that eventually growth returns. Back then, after four years, output in the UK returned to its peak. The shrill “back to depression” voices ignore this self-correcting mechanism.
Besides, this really does feel like the early 1980s. There has been mismanagement of the economy similar to that of the 1970s, and the incoming government has to correct the errors. Back then, the fiscal squeeze imposed by Sir Geoffrey Howe was similarly criticised, famously by 364 economists in a letter to The Times. There was indeed a recession similar to this one and the cuts were made a little earlier in the cycle. Yet the economy grew strongly through the 1980s — too strongly as the boom got out of control. This is not to claim the policies were optimal, simply the opposition to them proved wrong.
It is always hard to prove the counter-factual: what would have happened had policies been different. But the early 1980s do give one clue to what might have happened. France carried on with a fiscal boost as the UK was pulling back. But after 18 months France had to reverse its policy and ended the 1980s with higher unemployment than the UK.
None of this should be taken to mean that the coming four years will be easy. It is difficult to cope with cutbacks in any walk of life and the numbers are so huge that some things will happen that could and should have been avoided. My point is a broader one. The developed world almost certainly is in the early stages of a growth phase that will last several years. We have a window to sort things out.