It is time for George Osborne to change tack
George Osborne has a choice to think about over his summer holiday that will have serious economic and political consequences. Is he going to allow policy to be dragged along in the wake of events, with decisions being shaped on the hoof in response to each new revelation of the UK’s dismal economic performance? Or is he going to try a more proactive approach and reframe his strategy to reflect the way the world has changed since he first set out his plans after the election in 2010?
This week’s grim output figures for the second quarter may have overstated the pace of the slowdown. But the big picture is one of stagnation since late 2010 and a fall in output per head of a shocking 14 per cent from its pre-crisis trend. Recent indicators show business activity has been weakening and the international economy has also been losing momentum. Contrast all this with the post-election forecast from the independent Office for Budget Responsibility, which suggested that growth would be running close to 3 per cent both this year and next.
In response, the government has already slowed the pace of fiscal adjustment, with this year’s target running well below what was set out in its first Budget two years ago. It has also come up with various ad hoc initiatives in areas such as infrastructure development, credit expansion and fuel duty. In addition, the economy has been supported by very accommodative monetary policy.
But the outlook still remains weak and the current programme calls for a substantial tightening of fiscal policy in 2013-14. Meanwhile, the chancellor still bases his strategy on the idea that the cutback in government spending will be offset by increases in private sector investment and trade. This has not happened so far and the recent messages from the CBI and the British Chambers of Commerce do not suggest that anything is going to change here any time soon. Instead, there is a sense of foreboding in the business sector about what might happen in the final quarter of this year, once the excitements of the Olympics are over and hard reality sets in.
So there is a strong case for a policy rethink, one that was well set out by the International Monetary Fund in its report on the UK economy last week. It accepted the overriding importance of reducing the massive budget deficit. But it argued that the pace of fiscal adjustment planned for next year should be scaled back if growth did not start to pick up soon, and said that such a move ought not to trigger an adverse market reaction if it was properly communicated. After all, the easier pace of adjustment this year has not prevented UK borrowing rates from reaching all-time low points.
It would be better for such a shift to be part of a deliberate strategy than for it to be forced on the government as the economy continues to stagnate. What is needed now is a sense of direction: a credible plan for coming through the present difficulties and emerging in a better place a few years hence.
So when Mr Osborne comes back from his summer holiday, he should deliver the following message. This government’s standing is reflected in its low borrowing costs. It remains determined to bring the deficit under control and, to demonstrate this commitment, it is reinforcing a series of bold structural reforms, in areas such as pensions policy, planning and benefits. It is going to give business the confidence it needs to make major investments, which means above all ending the policy uncertainty in critically important areas such as energy. And it is going to recognise both the short term needs of the economy and the long term requirements of the country by a series of one-off fiscal initiatives designed to boost demand. One sensible suggestion from the IMF was for temporary tax cuts targeted at lower income households, who would be likely to spend rather than save the benefits. Also sensible would be measures to support the construction sector, housing above all, which is one of the main drags on output and where investment for the future is so badly needed.
Such a change of tone would be politically very difficult for Mr Osborne, given the amount of personal capital he has invested in the austerity programme and the UK’s triple A credit rating. But that rating will increasingly come into question anyway if the economy continues to weaken. If stagnation were to continue for another year or two, the political consequences of sticking on the present course would be a whole lot greater.
The writer is chancellor of the University of Warwick, a former director-general of the CBI and a previous FT editor