Breakingviews - Hadas: Election shunts UK towards state splurge



LONDON (Reuters Breakingviews) - It’s election time in the United Kingdom, and political parties are deeply split about most major issues. On the subject of government spending, however, there’s a surprising outbreak of consensus. Both the Conservatives and the Labour party have just announced similar fiscal frameworks. They are edging towards the new conventional wisdom among economists – government borrowing and spending can be good for national economic health.

Large budget deficits first became fashionable in the 1930s, when they helped end the Great Depression. The appeal of fiscal rectitude has fluctuated ever since. Ironically, the most recent push to balance budgets gained traction during and after the global financial crisis of 2008, when growth slumped and borrowing shot up. 

Perhaps to hide the reality, U.S. President Barack Obama held a summit on fiscal responsibility in February 2009. The following year, Britain’s new Conservative-led coalition government promised years of austerity. Some continental European politicians praised “expansionary fiscal contractions”.

In Britain the tide seems to have turned again. Though the economic self-harm caused by leaving the European Union has yet to be felt, budget cuts are politically unpopular. The Conservatives still promise that tax revenues will match current government spending, but only three years from now. They also intend to borrow up to 3% of Britain’s GDP every year to pay for investments. The rival Labour plan foresees fiscal balance after five years and a borrowing limit of 4.5% of GDP.

Neither set of numbers should be taken too seriously, as they were released in the beginning of a bitter election campaign. Still, the change in direction is clear. The Conservatives have abandoned their previous goal of what Germans call a “black zero”, where total tax revenue slightly exceeds all spending. Labour’s approach seems to be to spend more than whatever the Tories are promising. The change of heart is not limited to British politicians. U.S. President Donald Trump pushed through big tax cuts with hardly a thought about the effect on the deficit. Few of his many opponents are calling loudly for fiscal restraint. On the contrary, many Democrats want some variety of a “Green New Deal”, where the government would spend heavily to reduce the impact of climate change. Such an ecological crusade would probably keep deficits high, even if it is accompanied by soak-the-rich taxes.

In the euro zone, politicians are still mostly stuck in the old thinking. That is not surprising, since the single currency is anchored on shared promises of fiscal restraint made in 1992, when such prudence was considered self-evidently good. Changing European deficit rules will require intense negotiations. Besides, the German government really is old fashioned. Despite negative interest rates, it is only just starting to contemplate borrowing more to pay for much-needed infrastructure improvements.

Even the Germans are likely to relax, though, as more leading policy wonks convert to the new consensus. Olivier Blanchard, who was chief economist of the International Monetary Fund until 2015, is speaking out for additional borrowing. So is Larry Summers, who was in favour of prudence when he was U.S. Treasury secretary two decades ago. The rise of ultra-chic “Modern Monetary Theory”, which treats inflation, exchange and interest rates as important, but ignores the scale of government borrowing, is another indicator of changing views.

The intellectual shift has deep economic roots. Developed economies are not growing fast enough to keep politicians, economists and voters happy. Back in 1990, British GDP per person had increased at a 2.8% annual rate over the preceding decade, according to IMF data. In 2007, just before the country’s banking system melted down, the 10-year trailing rate was 2.4%. According to the latest IMF forecasts, 2019 will end a decade of 1.1% annual growth per person - despite including a recovery from a deep recession.

In the most recent decade, growth in GDP per person has been weaker in the United Kingdom than in Germany (1.7%), the United States (1.6%), and Japan (1.4%). However, the pattern of a multi-decade decline is similar in all the large developed economies.

Economists have numerous conflicting and complementary explanations for the slowdown, which is another way of saying they don’t really know. However, one thing is clear: the post-crisis consensus for tightening state belts has not worked as well as hoped. The practice of governments trying to shrink fiscal deficits while central banks slash interest rates and buy bonds has not pulled the developed economies out of their slower growth trajectory.

That poor record makes bigger fiscal deficits look like a worthwhile experiment. However, if durably higher growth rates are the goal, government spending probably needs to be supplemented by the sort of structural changes which have helped lower Germany’s unemployment rate from 11% in 2005 to 3% today. British politicians could start by cancelling Brexit. That would do more economic good than any amount of borrowing and spending.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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