“Insanity is doing the same thing over and over again and expecting different results”
A. Einstein
When David Cameron and George Osborne became Prime Minister and Chancellor respectively in 2010, they used a political tactic that proved highly successful – blame the last government for leaving the economy in a mess to justify higher taxes and lower public spending. Keir Starmer and Rachel Reeves are using the same Tory playbook. It won’t work!
Yanis Varoufakis, the ex-Greek Minister of Finance and an outspoken leftwing liberal economist said that the 2008 Global Financial Crisis policy combined “…austerity for the masses and socialism for the financiers [bankers]. That is what has been happening since the great financial collapse of 2008”. I never thought I’d agree with a Marxist, but he’s right. After Lehman Brothers collapsed in the autumn of 2008 triggering global panic, governments around the world pumped billions into saving banks and the global financial system. However, they panicked as debt levels rose (even though they were easily sustainable) and so kept tax rates high and slashed public expenditure. This was all based on the philosophy that an economy should be run like a family budget, something espoused by Margaret Thatcher during the 1980s. Only it doesn’t work when economic growth and productivity are low and when the public are saving. Keynes understood this but he fell out of fashion before the end of the last century.
The first 100 days in office are meant to be the most important period for any new government so this doesn’t augur well for our future. References to a so-called £20 billion hole in the UK government’s finances (a mere trifle compared to the size of our economy) won’t wash. Neither will silly fiscal rules that promise the working and middle classes jam tomorrow but not today.
Starmer’s government argues that our net debt is too high. At around 100% of GDP (Gross Domestic Product) it’s just about in line with its long-run average, and significantly lower than the eye watering 259% of GDP that it hit post-World War II. Despite this high point, UK government debt dropped quickly in subsequent decades to a low of 28% in 1990. How did this happen? Growth! Simple as that.
In the post-WWII period, the US Marshall Plan helped to rebuild Europe into a more competitive industrial base than it had been before the global conflict. If you can keep your economy growing, debt is not a problem. However, growth needs capital and if companies and families won’t invest then the government needs to step in. It’s not as if there aren’t lots of investment opportunities: how many times does your mobile phone cut out when you’re driving around the country? We need investment in 5G. What about the roads you are driving on? Or the school or hospital you may be travelling to? Plus, the sources of energy needed to run buildings and other networks. The latter is especially interesting because, thanks to China, the cost of building renewable energy infrastructure is now lower than building fossil fuel plants.
In economics, savings must equal investment. You may think that’s crazy, but just think for a moment – if a bank cannot lend the money you deposit to someone else that wants to borrow it, why would they take it from you in the first place? Savings must go somewhere and at times when companies and individuals are boosting their savings rates, as has happened over the last 15 years, the government needs to step in.
Sadly, Cameron and Osborne missed an opportunity to invest in the UK. They weren’t the only ones because post the Global Financial Crisis, governments around the world assumed that fiscal multipliers were well below 1.
What is a fiscal multiplier?
A fiscal multiplier is a way to measure how much a change in government spending or taxes affects the overall economy.
Imagine the government spends £1 billion to build new roads.
- The workers who build the roads earn money and spend some of it at local shops.
- Those shop owners then make more money and can hire more workers and buy more supplies.
- The money circulates through the economy, making the total increase in economic activity larger than the initial £1 billion spent.
If that £1 billion spent by the government results in £1.5 billion of total economic growth, the fiscal multiplier is 1.5, but if the fiscal multiplier was, say, 0.5 it would mean that the extra £1billion spent by the government would generate only £0.5 billion in economic growth. So, the fiscal multiplier shows how much impact government spending or tax changes can have on the overall economy.
In January 2013, the IMF published a report indicating a likely miscalculation and that fiscal multipliers post-crisis were significantly above 1, which would have been a golden opportunity to invest in our country and stimulate growth at the same time.
This may all seem a bit depressing, but take heart; things are changing. Governments have noticed that disaffected voters are looking to alternatives rather than mainstream political parties to get them a better deal. By “alternatives” I mean the right, which is having a resurgence throughout Europe. If centrist parties want to retain power, they will need to come up with more innovative solutions than the ones they have foisted on the public for the last 15 years.
“So, my advice to our new Prime Minister and Chancellor is to ditch austerity and go for growth, especially in the field of renewable energy.” – Gary Reynolds, CIO.
That might be a tall order for an ex-Director of Public Prosecutions and a traditional Bank of England economist, so they should take inspiration from another ex-lawyer, Franklin D Roosevelt. He introduced his “new deal” after being elected to the US presidency in 1933, turning the economy around after the ravages of the 1929 Stock Market Crash and subsequent Depression using the mantra “We have nothing to fear but fear itself”. This sentiment is rather different to the messages of doom currently emanating from 10 and 11 Downing Street!
The new Labour government has until the 13th October to do something meaningful and positive within their first 100 days. Perhaps they are saving the radical messaging for the Chancellor’s Autumn Budget statement on 30th October which, I hope, will promise more than just pain and tax hikes. After over 15 years of austerity, the country is itching for change. Ordinary British families don’t have another notch on their belt to tighten, so come on Keir and Rachel; ditch the failed Cameron/Osborne playbook and employ the successful ones of Roosevelt and Keynes. You know it makes sense!