Oct 24 2009
Do large deficits produce recovery?
When the government at last acknowledged we were going into recession around the turn of the year 2008 they told us two things. This was, they said, a US crisis created by their sub prime lending. The UK was uniquely well placed to limit the collateral damage from across the Atantic. Neither of these statements was credible at the time, though the spin machine ensured they were widely circulated. After yesterday’s poor GDP figures, no-one surely can go on believing them.
Yesterday the government and the BBC’s Economics correspondent moved on from blaming the Americans, and drew instead comparisons with the downturns in Japan and Germany, which were sharper in the last quarter of 2008 and the first quarter of 2009 than in the UK. They ignored the fact that of the large economies China, India, and Canada performed much better, that Australia had no recession at all, and only mentioned in passing that the USA and France also experienced a milder downturn.
Germany and Japan experienced a sharper downturn at the worst point for the world economy, because their economies depend heavily on successful exporting industries which were badly hit when Western demand fell off a cliff as excessive private sector borrowing came to an end.
Japan is an important economy to study. It has performed very badly ever since its own Credit Crunch in 1990 left it with large and gravely weakened banks. There have been endless reflationary packages, a massive expansion of government borrowing, and money printing. None of it has stimulated decent growth again on a sustainable basis. It shows that if you prop up banks but delay sorting them out, you end up with slow growth or no growth.
Conversely, Canada which had a major budget deficit and public spending reduction exercise in the 1990s, cutting back by 20%, has performed much better even though it is an economy much closer to the US than the European ones. Australia has shown greater budgetary and monetary discipline than poorer performing economies. China did apply a very large stimulus, but from a position of huge financial strength.
The figures for UK output and income may be modified upwards a little, but no-one can get away from the fact that the UK economic performance is very poor. The reason is simple – it is the treble deficits I have been talking about for months. The UK has banks that are too big and now too damaged and too regulated to be able to lend sensible sums to the private sector.It has a government which pre-empts too much of the money.
The figures are not necessarily an obstacle to government strategists, who are on an election stategy more than they are on a recovery strategy. The Chancellor has from time to time predicted the start of recovery around the turn of next year. Ministers probably want an excuse to continue with record levels of public spending and borrowing in the pre-election period, and may well like the idea of more money printing. The calls will now go up from Labour that given the weakness of the economy, now is not the time to remove the stimuli.
Ministers should be asked to explain why economies with much lower deficits and no money printing programmes are recovering earlier or having milder downturns. They should be asked why even the US has done better than the UK. They should be worried that their toxic mixture of bad bank regulation, state support for bad banks, large state borrowing and money printing has so far failed to work.
23 Responses to “Do large deficits produce recovery?”
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
As long as Labour can limp on with the scorched earth until May, they don’t care about the economy. They’re quite happy to cause long-term damage by short-term recklessness, just as long as they can salvage a few seats.
The lack of back-bench attendance in the Commons demonstrates how many Labour MPs have thrown in the towel, so they don’t expect to have to provide a proper solution.
I am sure they will say that growth is “just around the corner” for the next 6 months. They will say that their economic policies over 10 years provided Britain with a platform from which growth, when it commences, will be strong and sustainable. In the meantime the effects of the world economic situation have impacted on the UK in a way nobody could have foreseen. But they took the necessary action to stimulate a return to growth and to protect their citizens in a way that the Conservatives would not have done. They will say that a return to Conservative rule will place the fragile-just-around-the-corner-recovery in jeopardy.
The real question is how will the shadow treasury counter that to best effect?
Labour hate Britain. Their mission was to change us – not to improve us.
How can you reconcile environmentalism with mass immigration ?
How can you reconcile ‘war of terror’ with mass immigration ?
I’m sorry to bang on about this, but the reason why Australia has done so well is that it has belief in itself. She is arrogant enough to put herself first – always.
Yes very depressing, but not at all surprising that we are now in the 6th quarter of recession. This mirrors the order intake my own small business, which shows 18 months of reducing sales, with no sign of improvement, no matter what action we seem to take.
When will Governments learn that money has to circulate in order for an economy to work.
If we all save and the Banks hold money in reserve, then less money circulating means less work for all.
I fully accept that we all need a sensible cushion of reserves for that rainy day, but years of Government promoting the living off of easy credit (something it has done itself) has screwed the normal and sensible rules which have been applied in years gone by.
I fear that will now be many years in slowly drawing ourselves out of this mess. Your comparison with Japan is a good one.
Perhaps the media will now realise that Brown & Co have taken them for a ride for the past 10 years.
Last night the BBC did a programme about the Wall Street crash. It included an excellent discussion with four US talking heads.
They thought five things are wrong with the American economy.
1. There are still banks too big to fail.
2. The US banks have not been reformed.
3. It is still too difficult to get credit.
4. There is an economic recession.
5. Main street is hurting and the large unemployment levels are starting to threaten social cohesion.
Sounds familiar? Much the same problems apply in the UK.
What we need is:
1. The break up of banks too big to fail.
2. Reform of the banking system, including bank regulation.
3. The unfreezing of credit lines.
They thought the current stock market boom stemmed from (a) the money the US government has printed, some of which has gone into the banking system and (b) the fact that firms had reduced their costs and increased their profits by making workers redundant.
What is the matter with our political class – urgent action is needed. Why are banking reforms not happening? Why are the Government and the media not leading a public debate on the subject?
Agree that Japan is a suitable case for study and has parallels with the UK, but I would question its money printing. The Yen would not have maintained its exchange rate had this occurred at the UK rate. The Japanese have a propensity to save.
Having spent the last week and a bit in Dubai, reading the local papers and talking to the locals, you start to realise how irrelevant the UK now is on the international scene. We have a lot of guys out there trying to flog stuff. They are up against the problem of UK company’s financial risk profile. UK prices may be a bit cheaper (in US Dollar terms), but will the company still be there come delivery time? Is there a bank guarantee behind them for this or that project?
George Osborne got some good press, he is considered to have the required plan for UK Renaissance. Climate change is the only international stage left for Gordon Brown to stand on, and I think we all now know that Copenhagen will be all talk and no walk; an ideal stage for Gordo.
To some it up, unless you are a big company with a large cash pile in your bank, (or if you are a bank), you have little hope in the Middle East. The big spenders there, have put the UK to the back of the filing cabinet until the next UK general election. You may think it is grim viewing the UK economy from the inside; but, from the outside looking in, it is actually worse.
When the rest of the world looses confidence in doing deals with your own nation, you are truly in the ****. It is difficult to measure just how much damage New Labour has done to this country; in a few years historians will write books about it. I do hope those books have a happy ending.
An excellent summary. Radio 4 had Prof Blanchflower on again yesterday extoling the government’s strategy, completely unchallenged or even questioned by the BBC interviewer. Vince Cable sort of agreed, though he has now noticed the banks arn’t lending. He should read this blog to find out why – and then alter his party’s line on the economy. Philip Hammond said its all about keeping long term interest rates low – true but it would have been better if he had been more forthright in attacking the Brown/Blanchflower/BBC line. Conservatives need to take the fight to the big spending + borrowing Keynesian-socialists as you are doing. Those who operate in the real economy know what you say above is right.
Surely the announcement that the new German government will cut taxes from 2011 as well as controlling spending is another clear indication that Gordon’s approach is completely bankrupt (in more than one sense). I get the impression that George Osborne pays close attention to what other countries are doing in this regard and will try to incorporate the appropriate bits in his policies.
That the deficits were problematical was entirely predictable, the economy is not the same as it was when these theories came into being. I posted on all this on Thursday 22nd. If the government go on betting double or quits, either “quit” will be called by the markets and that will be a disaster, or the disaster will have already occurred.
By getting a landslide to wipe out Labour for as long as possible. About 30 years would see me out!
It’s interesting you mention Japan, as I live there. The Japanese government is now hitting the buffers though, as the savings rate has been declining since the popping of the bubble. This year the Japanese will only save 5 trillion Yen, but the government planned to borrow 33 trillion Yen. The new government has now taken an axe to that borrowing plan, a lot of construction projects have been suddenly cancelled.
The vast debts of the government, coupled with the demographic time bomb, plus the recession, looks like they will combine to produce a toxic trap. As least they don’t have a government that hates the people and tried to destroy their own culture.
Large deficits do not produce recovery. Nor does inflation, except in the very short term. We have been here before.
In 1972, the Heath/Barber axis panicked because unemployment had reached ONE million. They implemented a massive public expenditure programme, financed by printing money. In 1974, Wilson/Healey took over and poured petrol on the flames. Result: GDP growth of over 5% from 1972 to 1973, followed by 3 years (1973 to 1976) of zero growth and hyperinflation (’stagflation’). So these two different forms of socialist government produced a disasterous result.
From 1987 to 1991, the Conservative government let go of the money supply, then recovered their grip. Result: GDP growth just under 5% from 1987 to 1988, followed by low overall growth from 1988 to 1991, the years of high inflation.
Plus ca change, ………………………
Another question is: how can it be with £ having fallen by c. 30% vs the € France and Germany are out of recession but we are not?
“Ministers should be asked to explain why economies with much lower deficits and no money printing programmes are recovering earlier or having milder downturns”
Indeed they should, but let’s be realistic here, there’s not the slightest chance that they could answer such a question – largely because they haven’t a clue as to why this is so.
Chuck: “there’s not the slightest chance that they could answer such a question”
It’d depend which minister you asked; you’d get ‘balls’ from Balls, an answer unrelated to the question from Brown, from Jackie Smith you’d hear an apology that wasn’t an apology, from Mandleson you’d get the next government post he proposed to awarded himself.
That man probably thinks the Crown is within his grasping fingers.
The important question is “What is recovery”? The stock markets across the world are up 40%. The Banks with casino investment arms are showing very healthy profits. However, the manufacturing companies across the world are very quiet with profits being generated mainly from overhead reductions.
This apparent anomaly is the fundamental problem of the as yet unfixed Banking crisis. Profits derived from the casino are not “real money” they are merely transfers from a losing investor to a winner. Theses profits are then used by the winners to pay bonuses, enhance balance sheets and borrow more money to gamble with.. and so on.
We have already proved, very painfully, that this was the basis of the present crisis and here we go again. Gambling with derivatives to make big profits is pointless. A method has to be introduced to connect this to the real world and …and soon. Let us not fool ourselves into thinking that any country is yet out of the morass.
You may enjoy “Why Budget Deficits are Bad for the Economy and Why Sir Samuel Brittan is Wrong”:
http://www.cobdencentre.org/2009/10/deficits/
“Toby Baxendale exposes flaws in the economic thinking of the left, indicates the dangers of deficit spending and points to a better way to fund welfare while stimulating genuine commercial investment.”
John
Ref a post you did a few days ago about how we should use British built car NOT IMPORTS. I thought this might quicken your pulse:-
http://green.autoblog.com/2009/09/17/frankfurt-2009-toyota-auris-hsd-full-hybrid-concept-needs-a-sho/
Rather than throw £200 million down the Vauxhall Rat hole (They be back just like BL for more) Why not do a deal with Toyota?
They are a far better bet for the furture, the “Requirment” for the car fleet could be drawn up in such away that Toyota/Honda Uk are “The only show in town”.
We see a LOT of goverment/NHS/ Other Agants driving about in Merc/BMW Lease hires………Why not give British engineering a BIG lift by putting in a cost/CO2 limt?
Your save money, cut imports, upset the French all in one.
Mike
The key is for the government to leave the stage and for the Conservatives, when they come in to get off the stage too. Leave it to the professionals.
This means:
Selling off the banks PDQ or freeing them up. Perhaps dividing off the “casino” bits from the “investment” bits. Letting the BofE run the show.
Lowering, yes, lowering, taxes quite radically. And allowing completely tax free zones in the North to act as seed beds for manufacture.
Cutting the State to ribbons. The amount of people standing between the minister and the people who are paid an arm and a leg to manage hospitals, for instance, can be reduced immediately to zero. The same is true of schools where the Heads should be freed up to run them as they see fit – like the Grammar Schools which are a real success.
The huge question is this:
Are the conservatives really that brave and determined?
Mike Stallard: “The huge question is this: Are the conservatives really that brave and determined?”
Not a chance, the potential next prime minister has, what experience? He knows how to present himself, he is an ex advertising executive.
Cameron is Heath lite, we all know where that led.
God help us!
I understand that the new German Government’s next phase of recovery is Tax Cuts. Has anyone this side of the Channel bothered to check what would happen to the UK if these policies were applied here?
We are being Brought to our Knees, sold out to Offshore Bankers.
You can’t have complete control over a people if they are independant and wealthy and that is what this is about, totalitarian control.
Fall of the Republic
Maybe your question is wrongly phrased. There are some circumstances where deficits can produce recovery. In old-school Keynesian language this was called a fiscal stimulus.
The conditions that it is best suited are when the slump is due to a deficiency of aggregate demand. It is characterised by an excess of saving and lack of investment. It will work best where government finances are strong. That is where there is a budget surplus (or near-balance) over the business cycle, and where government expenditure is low and/or falling as a percentage of GDP.
I would propose that the current slump is not due to a deficiency of aggregate demand, but a correction of imbalances in the economy. In particular there has been over-investment, shown by a housing-price bubble. On top of this we have had 7 years of continual fiscal stimulus, changing the government’s finances from being the best in over a century to a record structural peace-time deficit – and that was in 2007. This was compounded by a monetary stimulus from very low interest rates.
A justification for a fiscal stimulus is that the deficit created will soon be paid back by an increase in total output and a reduction in unemployment. Instead of subsidising the unemployed, you will get employed people paying taxes and spending the rest. I believe most of the deterioration in the government’s finances is not from this source, nor will the stimulus have much impact.
The risk is very great that not only is the spending being wasted, it will lead to an ever-increasing national debt. With the structural deficit at around 6% to 8% of GDP, nominal GDP will have to increase by an amount greater than this in the long-term for the national debt to come down. Unless the government creates inflation to erode the debt, we need real cuts of up to £100bn in government expenditure, even allowing for the increased interest payments. The government who says that they care most about public services, as created the Devil’s Alternative. We either make massive cuts when people are most in need and financially the most vulnerable, or we ignore the problem and make more drastic surgery necessary later on.