Labour and the economic outlook for 2012
The country has entered 2012 in a general gloom. This is evident amongst economic and political commentators and in the media, but it is also apparent in the pervasive sense that people have been hunkering down, unsure of the future. The economic outlook deteriorated markedly last year. The earthquake in Japan disrupted the global economy but it was the inability of European governments to tackle the debt crisis in the eurozone which had the most impact. Market confidence that countries had the will to tackle public sector debt was severely shaken in August amid concerns that not only did the European Union lack resolve but that there might be an impasse over the US budget too. Concerns about the US have allayed for now but big questions remain about how the eurozone sovereign and bank debt crisis will be resolved.
That hit to confidence over the summer, because it was not reversed by action in Europe, fed through to business and consumer confidence. If you run a business and you are worried about a financial crisis which might hurt banks, you would be very tempted to postpone investment decisions eg to build a new factory or take on more staff. As a consumer, concern about a financial crisis could lead to a reluctance to borrow more and instead to a renewed focus on paying back debt and saving for a rainy day (the VAT hike also hit consumer spending power last year). Combine the two, and the economic outlook begins to look very grim and recessionary.
The immediate outlook therefore appears to be one of low or no growth for months or even years to come. Some economists now think this would be a result since the alternative would be deep recession. The experience of past financial crises is that recoveries afterwards do tend to be slow as debt burdens are unwound. We need businesses to invest but even though larger companies have strengthened their balance sheets and so could borrow more, finance directors feel they need insurance against any future banking failures.
Meanwhile low growth means lower tax revenues and sustained welfare bills. That means deficit-cutting targets are being missed and tighter austerity measures are being employed to get back on target ie more spending cuts and higher taxes (eg Spain at the end of December). Even the UK has announced further spending cuts (to take place in the next parliament) as its economic strategy has hit reality. So countries have embarked on austerity death spirals as more austerity leads to lower growth, to more austerity etc etc.
Something else is happening however and that is a change of expectations. We might bemoan European leaders for ‘kicking the can’ further down the road at each crisis summit rather than dealing with the fundamental causes of the problems in the eurozone, but each kick represents a further adjustment of expectations, both of the leaders themselves and the people they represent. That adjustment is two-fold: a growing realisation that rapid economic recovery might not be imminent, and a growing realisation of the scale of the measures needed to sort the problems and avoid financial catastrophe. That adjustment has further to go and we can expect radical action probably only when the costs of doing otherwise outweigh any difficulties people are worried about.
There are parallels in the UK as people come to expect little change or even further deterioration in their living standards, with a government lacking the ideas or the will necessary to promote sustainable growth. Instead, the Conservatives and Liberal Democrats promise more austerity. There is some hope that the average household might have more spending power this year compared to last as the VAT increase and higher food and fuel costs last year drop out of the comparison. Perhaps, but such hope also relies on a slowing of deleveraging and a willingness (and ability) of some to borrow more. Moreover, at the time of writing the oil price has surged on the back of concerns about Iran. If that was sustained, the price index might be higher than the Bank of England expects this year. If growth does not pick up (and it might), unemployment may remain stubbornly around 8% or higher and the pressure on the government to do something will be intense. Expect, if this happens, for some sort of temporary tax cut or boost to spending (perhaps via more Quantitative Easing); whatever its form it probably will not be enough and its temporary nature will undermine it (echoes of Japan maybe).
Lest we become too pessimistic let’s not ignore the current positive signs of life from the US economy. Less keen to rein back on fiscal stimulus too quickly, and less exposed to the rest of the world (eg European problems have less impact than for the UK), it is possible to imagine the present pessimism lifted by higher-than-expected growth in the US.
Nevertheless, what is needed in the UK is a government proactively committed to promoting growth. Businesses and families need to have confidence the government will do this for years to come, rather than rely on growth gimmicks. With public finances so stretched the theme has to be investment: investment in our people, including jobs guarantees and a focus on education, and investment in our infrastructure (physical and virtual). Alongside this, the tax system needs to be simple and stable and a national investment bank should be established.
These measures could be part of a clear alternative economic narrative that Labour could promote. They would help bolster its economic credibility with the electorate and with markets. Credibility-building also requires a clear approach to reducing the government debt burden over time and a new approach to spending. I outlined these in The Credibility Deficit, a Fabian pamphlet published at Labour Conference last year. Since then, it has become more widely accepted that Labour should say more about cutting deficits. However, what matters is not following George Osborne’s latest plan but being credible.
Central banks are struggling to head off general inflation while dealing with price shocks that will be negative for growth. They waited too long, which has made their tasks more difficult.