Beware the balancing act in George Osborne’s false economy

George Osborne At Reception

The more one sees of George Osborne – and this is not a chancellor who keeps himself to himself – the more he appears to be a practitioner of the false economy.

Everyone knows what a false economy is: you make a shortsighted saving which only serves to postpone the agony and leads to the need for greater expenditure in the future. In Osborne’s case, this criticism applies at both the macro level (policy that affects the workings of the economy as a whole) and the micro level (policy that affects individual sectors, both public and private, and the household).

The two are inextricably linked, because an austerity policy aimed – for reasons that puzzle many economists – at a budget surplus on both current and capital account has a serious impact on many “micro” activities.

Now, individual citizens know that, unless they have won the lottery or come into a sensationally large inheritance, they cannot purchase a flat or house with one year’s earnings. No: they take out a mortgage, and repay over many years. This is what is known in the trade as capital expenditure, an investment for which long-term finance is required.

Indeed, before we entered the mad world of endless streams of credit, spending on refrigerators, washing machines and the like was regarded in effect as capital expenditure, and there was a system known as “hire purchase”, under which many consumer goods were paid for over several years. The derogatory term for this was “paying on the never-never”, but it made good commercial sense.

In macroeconomic and budgetary policy for many years, the government’s accounts were presented in two parts: “above the line” (the balance of current spending on, for example, pay for doctors, nurses and other public sector workers) and “below the line” (the cost of capital investment on, for instance, the infrastructure).

The accepted aim was for balance in current spending over an economic cycle, whereas it was understood that balance would take longer with capital expenditure: as with the publicly quoted corporations in the private sector, there would be borrowing to finance an investment, and the returns would accrue later.

But by lumping current and capital spending together when calculating the balance of the national budget, Osborne is, for apparently doctrinal reasons, deliberately squeezing annual current spending by a lot more than would be necessary to achieve balance in current spending, let alone a surplus.

This, plus another apparently doctrinal bias in favour of public spending cuts rather than tax increases, explains why we are now witnessing all too many examples in the public sector of false economies: cuts that hurt now, but can be guaranteed to lead to the need for emergency expenditure in future, expenditure which may well exceed the savings made in the short term.

What should matter in economic policy and the performance of the economy is balance in the economy as a whole, and as full a use of resources as is consistent with a tolerable rate of inflation, a viable balance of overseas trade and payments, and longer-term considerations about the environment. This latter point is of course the driving force behind the concern about climate change.

It is hardly a good use of resources and economic potential if the budget is balanced when unemployment is still high and inflation is negligible. One of my main criticisms of Osborne’s macroeconomic policy has been that by imposing his restrictive budgetary policies at just the point when the economy was recovering from the Great Recession, he ensured that we had the slowest recovery on record.

Even now, although unemployment is much lower than it was, there are many people working part-time who would rather work longer, and inflation is hardly a constraint. Indeed, in this country we had decades when incomes policies of various sorts were used in an effort to keep inflation down; now we have “living wage” policies and chronically low interest rates in an effort to raise inflation to the official target rate.

Yet with the world economy evidently slowing down (dramatically, in the case of emerging countries dependent on raw material exports), the eurozone extremely weak, and our own manufacturing industry affected by all this, the chancellor is still set on that budget surplus.

In the attempt, at the micro level he is drastically curbing central government grants to local authorities. The result is that we see false economies all over the place. Cuts to the budget for social care put extra strains on hospitals that are already overstretched, as I saw at first hand during a recent stay in a London hospital after incurring a minor injury.

At the macro level there has been a false economy in the policy of not investing in a major way in infrastructure when interest rates were at rock bottom for so long.

Even Osborne may well come to regret this. If, thanks to a combination of strategic blunders on the part of David Cameron and events, we end up with “Brexit”, then the reaction of the financial markets, which are already beginning to wake up to the seriousness of the trade position, could be devastating. In such a crisis, the implications for interest rates hardly bear thinking about.

Powered by article was written by William Keegan, for The Observer on Sunday 13th December 2015 07.00 Europe/London © Guardian News and Media Limited 2010


JefferiesAnd the Best Place to Work in the global financial markets 2016 is...

Register for Financial Markets News Alerts