Policy Research in Macroeconomics

Cuts will not end the crisis

By Michael Burke

Tumbling stock markets, riots in the streets and rising unemployment are not signs of economic confidence, despite George Osborne’s assurances. The British economy remains in a depression, defined by the authoritative National Institute of Social and Economic Research as any period in which output remains below its previous peak. The UK depression has already lasted three years, and NIESR argues that is likely to last five years or more – longer than that of 1930s.

Yet economic debate is dominated by counterproductive attempts to reduce the deficit through cuts in public spending, which are now the single most important cause of the depression. Before the cuts of last October’s comprehensive spending review, the economy had grown by 2.5%. Because of the slowdown the government will miss its targets to reduce the deficit by some distance, an entirely self-defeating policy.

The notion that stagnation is the necessary consequence of deficits and debt inherited from a profligate Labour government is nonsense akin to the Tea Party-led hysteria in the US, yet this view dominates the debate in Britain. The budgetary squeeze introduced by the coalition government has brought about lower aggregate demand, which lowers business confidence in the growth outlook. Critically, private sector investment has almost collapsed, and it is this slump that now accounts for 80% of the total output lost since the recession began. In the first quarter of 2011 GDP was £56.3bn below its peak level in the first quarter of 2008, and the fall in private sector investment (gross fixed capital formation) is £44.9bn.

No sustained recovery can take place without breaking this pattern. Yet, even though the earnings of the UK business sector have recently risen, a falling share of retained earnings is going to investment. The share of capital spending out of retained earnings in the fourth quarter of 2010 was about half its historical average, or the lowest since records began in 1987, and has not improved. Since the private sector is unwilling to invest, some mechanisms must be found where the public sector can temporarily take over that investment function.

The government already has majority shareholder control over both Lloyds-TSB bank and RBS (as well as Northern Rock). Part of RBS could be turned into a British Investment Bank. The idea is hardly new: not only is there a European Investment Bank but public investment banks exist in Germany and in the Nordic countries. It would fund the necessary investments in housing, transport, infrastructure and education, raising the productive capacity of the economy and getting people back to work. Of course, the private sector would want to participate once it saw growth was back on track, just as it did in the brief recovery that was derailed by the government’s cuts.

It is frequently asserted that there is no money to finance investment. But the government can now borrow long-term funds at less than 2.5%, and returns on investing in affordable housing would be treble that. Similarly, the OECD has identified increased investment in higher education as a way to reduce the deficit, given the much higher tax returns from a highly skilled workforce. Investment in rail also yields very large returns. The deficit would fall with this investment. But there is no need to call on government borrowing in the first instance. Under the extremely robust stress tests conducted by the Financial Services Authority, RBS still had a capital cushion that would allow it to increase its lending significantly.

Politicians must be prepared to take on the banks’ continued failure to serve the common good.

Welcoming this turn in the debate, Jon Trickett MP commented, “‘Many people might think it poetic justice to require the publicly owned banks to serve the public, and not the bankers”. The longer the UK economy stagnates, the greater will be the pressure to formulate a plan B. We must ensure that it is a progressive plan B, not an even more regressive one. As Ed Miliband said during the 2010 Labour leadership race: “We can’t just go back to business as usual when it comes to the banking system … We’ve got to look at all of these options, not just mutual ownership by the way, public ownership, because that’s what they do in other countries like Germany, where they’ve succeeded in building a bigger industrial base.”

This is absolutely right. A publicly owned investment bank and government investment are central components of any properly designed strategy aiming to help Britain escape from depression and regain prosperity, as we discuss in our new pamphlet.

This article was originally published on the Socialist Economic Bulletin and the Guardian Cif >

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