The Osborne Ultimatum

17th August 2012

While a bitter blow to the Chancellor after the UK fell back into recession this year, their criticisms pose an interesting question – have we finally overcome fear of the confidence fairy?

Back in 2010 the government was riding high on election momentum and the collapse in the Labour party's economic credibility among voters. Austerity was never going to be an easy policy to sell but Osborne's "Plan A" was given credibility by the support of number of high profile figures including Roger Bootle, managing director of Capital Economics, Kenneth Rogoff, professor of economics and Thomas D Cabot Professor of Public Policy at Harvard University, and the chairman of the Independent Commission on Banking Sir John Vickers.

Even as recently as June last year the Chancellor was being praised by Pimco, the world's largest bond fund manager. In an investment note Saumil H. Parikh, a member of the Pimco Investment Committee, stated that "at PIMCO, we think the U.K. is implementing what is probably the best combination of fiscal and monetary policies to address deficit reduction, as they have an eye to structural issues".  A more glowing endorsement could hardly have been wished for.

So what's happened since?

Clearly the arrival of a double-dip recession has done little to convince the public that the government's economic plan is functioning as it should. According to the Office for National Statistics the country's GDP contracted by 0.7% in the second quarter of 2012, its third consecutive quarterly fall.

Sovereign debt difficulties in southern Europe have undoubtedly had an impact both on sentiment and trade. As Britain's biggest trading partner, ongoing economic problems in the region have helped to drive the UK's trade deficit to its widest point since 1997. Although declining North Sea oil revenue played a part in this a £4.4 billion gap between imports and exports is a serious problem almost five years on from the start of the crisis.

Identifying the problem, however, is not the same as finding the solution. Osborne has repeatedly bemoaned the "disappointing figures" but he has also tried to convince his supporters that without his plan to deal with the debt they would be an awful lot worse. Unfortunately that group appears to be getting ever smaller in number.

What the economists say

Most of the responses to the New Statesman article appear to have followed John Maynard Keynes's dictum: "When the facts change, I change my mind."

A repeated refrain is the call for the government to increase spending, whether for infrastructure projects or house building, to provide the basis for a sustained recovery. In order for them to reach these conclusions, however, a profound shift has had to happen among this circle of economic dignitaries.

This shift is best described by Danny Quah, professor of economics and Kuwait Professor at the LSE, who writes that the "fear that UK borrowing would become overly costly has become much less relevant". That is the confidence fairy, if she ever existed, has finally been removed from the conversation.

In itself this marks a paradigmatic change in the terms of the debate. No longer will the political left's answer to austerity have to focus on timing spending cuts (a Plan A½) but it should now be able to challenge the basis of cutting for growth.

For some, it has been far too long in coming. Back in April, Paul Krugman declared that the "this was the month the confidence fairy died". Yet despite the New Statesman appearing to have put the last nail in the coffin, Britain is as far from engaging in a genuine program of fiscal stimulus as it was in 2010.

The failure to act despite changing circumstances would not surprise the American. Osborne has tied his fate, and indeed the fate of his prime minister, to the success of Plan A and so whether he believes, as Krugman suggests, that "any relaxation of austerity would cause borrowing costs to soar" or not has become a moot point.

No doubt there is a complete alphabet's worth of good alternatives out there. Sticking with a plan that isn't working may cost the Chancellor his job, but it could cost the public far more.


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