What Cameron Can Do About Britain’s Shrinking Economy
The London Olympics open Friday, and let’s hope they go well. The host country could use some good news.
This week’s figures for U.K. national output showed a surprisingly big contraction of 0.7 percent in the second quarter, deepening a double-dip recession.
There’s no longer much question about it: Prime Minister David Cameron’s government needs to loosen up its austerity-focused fiscal policy. Admittedly, the latest growth figures are puzzling, leading some analysts to ask whether they can be trusted. Employment and tax receipts grew faster than you would expect if the economy has slowed as much as the new numbers say. Special factors like an extra public holiday and unusually wet weather (even by British standards) probably made the outcome worse.
Even allowing for this, the U.K. is doing worse than much of Europe, despite the fact that financial markets aren’t yet questioning its ability to borrow. Quite the opposite: Real long-term public borrowing costs for the U.K. are close to zero. This gives the government a choice denied to many of its European Union partners: It can ease fiscal policy. Moving cautiously, it should.
Cameron and his Treasury chief, George Osborne, have made this harder for themselves than it needed to be. Promising not to deviate from tough budget austerity, they have emphasized steely inflexibility. That’s the wrong posture for a time of acute economic uncertainty. To their credit, with the economy underperforming, they have already deviated a little. They need to deviate more and to stress adaptability over resolution.
This is a case where Cameron should avoid the politician’s temptation to pretend he isn’t changing policy. That would only constrain his ability to act with the speed and depth required. Cameron needs to delay fiscal consolidation and make it plain that’s what he’s doing.
Then, he’ll have an instrument that’s ideally suited to delivering reversible fiscal stimulus, the value-added tax. A one-year VAT cut would lower retail prices and encourage consumers to bring purchases forward, giving a temporary boost to demand. He should supplement this with a new program of spending on infrastructure. This is investment that the U.K. badly needs in any case, and whose financing cost in inflation-adjusted terms is less than nothing at today’s interest rates.
The Bank of England can help, too. It has already acted boldly to provide monetary stimulus in orthodox and unorthodox ways. It has cut short-term interest rates close to zero, bought assets -- quantitative easing -- on a large scale, and has tried new ways of helping the low cost of money feed through to greater bank lending. Yet there’s room for more monetary easing. For instance, the bank should announce that the current program of quantitative easing, due to end in November, will be followed by another.
Cameron should blend further structural reforms with the fiscal flexibility that we’re advocating. The negative second-quarter growth figures suggest the disturbing possibility that U.K. labor productivity is falling fast -- this would explain the combination of relatively fast employment growth and shrinking production. So the government needs to make sure that extra demand from further stimulus will energize new output. Tight planning regulations, for instance, are holding back construction. Cameron and his team need a more ambitious supply-side agenda.
Cameron is right to be fiscally cautious. The U.K. must not take its access to cheap long-term funds for granted, because its underlying fiscal position is bad. As a yardstick, economists at the Organization for Economic Cooperation and Development estimate that the country’s primary budget balance (excluding interest payments) would have to improve by 8.5 percent of GDP immediately to bring public debt down to 50 percent of GDP by 2050.
That’s sobering, and it justifies the government’s long-term fiscal goals. At the same time, it misses the point: Continued short-term tightening under current conditions is probably counterproductive, even in trying to reduce the budget deficit. By worsening the recession, as it seems to have done, overzealous austerity has dug the U.K. into a deeper fiscal hole. There’s no virtue in sticking with a failing policy.
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