After Roosevelt was pushed to cut government spending in 1936, the great depression kicked off again, with employment dropping down again in 1937-8. We mustn't risk this happening again. Left axis: total US workforce (excluding WPA and farms), in 1000s. Source: US Census Bureau
It is no wonder the Tories want to concentrate so much of their fire on the election sideshow of national insurance. There is so much in the implications of their own economic policies that they understandably would want to hide.
To understand what is at stake, it is important to grasp the key difference that has arisen on the response to the economic crisis. The most recession since the Second World War will continue to have long-term consequences, even if there is no renewed economic contraction. That prospect, a “double-dip” or “W-shaped”’ recession, cannot be ruled out. The positive effects of lower interest rates and a weaker pound will gradually wear off. In any event, lower interest rates are designed to lead to increased bank lending, but loans are still declining.
Similarly, a weaker currency should lead to stronger export growth, but there is no evidence of that yet. Both remain weak, partly because investment has plummeted, with fewer businesses seeking new funds and British exports suffering from a lack of competitiveness.
In addition, unemployment, business failures and home repossessions nearly always continue to rise even after aggregate measures of gross domestic product start to expand, which will tend to undermine recovery prospects.
Therefore, the key to the situation remains fiscal policy – what the government is willing to do to sustain recovery by spending and investing on its own account.
Here, Labour has a genuine success story to tell. The 2009 Budget added £50 billion to the economy in three different ways. First, there was a rise of £24 billon in recession-related spending, mainly welfare payments. Economists’ jargon sometimes calls these payments “automatic stabilisers”. They certainly serve to stabilise the economy in a period of sharp downturn. However, they are only automatic if the government allows the spending to go ahead. We know from the declarations of the Tory frontbench that the Conservatives would not have let these “automatic” payments happen. Their first resort was to take an axe to government spending, cutting services, welfare entitlements, pay and public sector jobs.
The same applies to the other areas of government spending in 2009. A further £21 billion was allocated to government capital spending, mainly on infrastructure projects and refurbishment of schools and other important areas. There was a further £5 billion increas in current spending, such as the car scrappage scheme and other initiatives, which tends to form the main focus of commentary in the press and elsewhere, but is clearly only a fraction of what was spent.
The great success story is that the Budget worked. The most important effect is that it boosted the economy. And, almost as important, given the distorted nature of the debate, it also had the effect of reducing the projections for the Budget deficit. This is the single most import mechanism for “reassuring the financial markets” and “maintaining the AAA rating”. Investors want to see a rising income stream to cover debt payments – in this case, the government’s tax income.
If government spending increases by £1 billion, GDP will increase by at least that amount, because government spending is a component of GDP. In addition, £1 billion spent on increasing education spending, for example, will push up private sector spending on items such as books and computers. Altogether, the boost to the economy will be more than £1.8 billion. The British economy is now 5.8 per cent below its peak level in the first quarter of 2008. Without the increase in government spending, it would have been just under 9 per cent lower, or at last half as bad again, with all the consequences for jobs, home repossessions and business failures.
This increase in activity also has a positive effect on government finances. Between the December Pre-Budget Report and the March 2010 Budget, there was a surprise increase in taxation of £9.5 billion and £8.6 billion for next year. Altogether, the Treasury expects this return to be £53 billion over five years, with projections for the deficit lower every year over that period and beyond. That
£53 billion is greater than the initial outlay of £50 billion and over time will provide a return far exceeding it. Most econometric models estimate returns on government investment that last 20 years or more.
There is also the substantial boost to government coffers arising from creating employment through investment, as welfare payments decline and taxes flow in from increased consumer spending.
The Tories would not have made that important investment and would have done the opposite. The effects would have been disastrous. They also intend to reverse it within 50 days of winning office.
The consequences of cutting public spending in a recession were spelt out by Peter Mandelson in a speech last year to the Work Foundation. He said then that the lesson of the 1930s was that public spending cuts in a recession depress activity, lower tax revenues and actually widen the deficit. He was entirely correct.
So it made no sense for the Business Secretary to announce cuts to the higher education budget, especially since the 200,000 young people denied places this year will otherwise be faced with unemployment.
It also made little sense for Chancellor Alistair Darling to discontinue the stimulus measures in 2010. They worked in 2009 and would work again. Recent International Monetary Fund research shows that stimulus works better over two years rather than one.
Its current approach is damaging Labour’s prospects for re-election. Of course, most electors do not pore over the GDP data or Budget details before casting their votes. But they do know if they are going to be denied a college or university place. And they clearly understand what’s in the pipeline through threats of being “worse than Margaret Thatcher”. The Tories’ lead had narrowed to two points in some opinion polls before that statement. After it, the lead was back up to double-digits.
Thankfully, Gordon Brown has declined to repeat that very damaging statement. And it is still possible to defeat the Tories, whose lead began to dwindle when they made similar threats at their October conference. But the task is not made any easier by many Blairites, who, through resignations, attempted coups and pro-cuts statements have repeatedly undermined Labour’s fightback. l
