Jeremy Warner in the Telegraph
What does the future hold as Europe slides, ever more hopelessly, towards the
abyss? As David Cameron has pointed out, there have been 18 EU summits since
he became Prime Minister little more than two years ago, and none of them
has produced anything remotely resembling a solution.
The stand-off got a whole lot worse this week. France and Germany are now in
open conflict over the way forward, if indeed there is one. For the UK,
already bleeding badly from the after-effects of the financial crisis, the
situation could scarcely look more threatening.
The fiscal consolidation chosen by the Coalition was always likely to have a
negative impact on output, at least in the short term. To make it work, the
Government needed the following wind of decent growth elsewhere in the world
economy. Instead, it’s facing a hurricane. We look set to be broken by the
storm.
But fear not – salvation is at hand. Next week, there comes to these shores a
Messiah, a prophet of great wisdom and understanding whose teachings promise
to vanquish despair and “end this depression”. He is Prof Paul Krugman, a
superstar polemicist who has been described by The Economist as “the most
celebrated economist of his generation”. Actually, “celebrated” is not
exactly the right word, for Krugman divides opinion like no other. To his
followers, he’s a saint; to his detractors, he’s a false prophet with
satanic intent.
I’ve been a little misleading here. He’s not really coming to Britain to save
us, but rather to promote his latest book, End This Depression Now! Krugman
is an economist with attitude, and he thinks Britain is in the midst of a
“massive blunder” in economic policy. The UK is the very worst example of
austerity economics, he believes, for unlike the poor beleaguered nations of
the eurozone periphery, we’ve not had this misery forced on us by the
ghastly euro, but have opted for it as an unnecessary penance for the sins
of the boom. If only we could be persuaded to forsake “Osbornomics” and
tread the path originally set out by our dearly beloved former leader,
Gordon Brown – that of spending our way back to growth – then all would be
well again.
Put like that, of course, it sounds ridiculous, but the fact that Krugman is a
Nobel prize-winning economist gives Labour’s calls for a U-turn on the
economy an intellectual credibility they would otherwise struggle to attain.
All the great economists – from Adam Smith to John Maynard Keynes – were as
much moral philosophers as dispassionate analysts of events, and Krugman is
no exception, preaching his message with all the passion of the religious
zealot. He feels our pain and begs us to let him help. “The road out of
depression and back to full employment is still wide open,” he insists. “We
don’t have to suffer like this.”
Krugman may appear loud and radical, but he follows a fairly standard
Keynesian text. By his own admission, the social cost of the present
downturn doesn’t come anywhere close to the Great Depression of the interwar
years, or not yet. None the less, there are parallels, and we already meet
Keynes’s classic definition of a depression as a “chronic condition of
subnormal activity for a considerable period without any marked tendency
either towards recovery or towards complete collapse”.
In such circumstances, monetary policy can help, but only up to a point. In a
depression, even those with the balance sheet strength to spend and invest
won’t do so, whatever the encouragement offered through ultra-low interest
rates. It follows that governments should step into the breach and do the
job instead, as a kind of spender of last resort. They can worry about the
accumulated debt later, once output has picked up again.
To Krugman, it’s understandable that policymakers screwed up so monumentally
in the Great Depression; they didn’t understand what was going on and there
was no template for the circumstances they found themselves in. To his mind,
there is no excuse this time around; it’s textbook stuff, which is being
wilfully ignored.
But haven’t we already tried borrowing to stimulate? And what did it deliver
other than fiscal ruin, which in the eurozone periphery is so serious that
markets have stopped lending altogether? Krugman has an answer for these
questions, too. It’s not the policy that was wrong, merely that the stimulus
wasn’t big and sustained enough. As for the eurozone, again, it wasn’t the
policy, but the euro. Countries with their own currencies and central banks
won’t run into this kind of problem. In extremis, they can always print the
money.
Easy peasy, then. What’s not to like? Well, I’m sorry, but I just don’t buy
it. It may or may not be possible for a vast, largely internalised economy
such as the US, with its reserve currency status, to run double-digit
deficits into the indefinite future without adverse consequences, but for
the UK it is a much more questionable policy.
True, Britain has lived with much higher debts relative to GDP in the past,
but this has nearly always coincided with major wars. With demilitarisation,
much of this borrowing to spend falls away and domestic consumption comes
roaring back. No such get-out-of-jail-free card exists this time around.
Further, the demographic is completely different from that of the post-war
baby boom generation, where growth and therefore debt erosion were more or
less guaranteed. Today, the unfunded liabilities of an ageing population
stretch menacingly into the long-term future.
As it is, government spending in the UK is already approaching 50 per cent of
GDP. Just how high does Prof Krugman propose it should go? It’s all very
well to say “jobs first” and worry about the deficit later, but once
government spending becomes entrenched, it’s very difficult to get rid of
it. Even Reagan and Thatcher struggled to make significant inroads.
In any case, the picture Krugman presents of wrong-headed British austerity is
a caricature of the reality, though one admittedly encouraged by the
Coalition’s rhetoric. Yesterday’s revised GDP figures, showing that the
country is even deeper in recession than we thought, would appear to support
the mocking tone in which Krugman condemns the idea of “expansionary
austerity”. But where is this austerity? In fact, one of the few positive
contributors to output in the last quarter was government spending, which
grew by 1.6 per cent. Krugman seems to have forgotten the automatic
stabilisers, which because of our welfare state are considerably bigger than
in the US. In America, much current UK spending would count as a
discretionary fiscal stimulus of the sort End This Depression Now! advocates.
As Raghuram Rajan, a former IMF chief economist, has argued, today’s troubles
are not simply the result of inadequate demand, but of major changes in the
world economy brought about by globalisation. The old monopoly of knowledge
and expertise once enjoyed by advanced economies has been swept away. For
decades, we compensated for the jobs and income lost to technology and
cheaper foreign competition with unaffordable government spending and easy
credit. Much of the growth enjoyed in these pre-crisis years was simply
unsustainable.
Paul Krugman’s message is seductive, but it’s also unrealistic. If only the
solutions to our plight were as simple as he thinks.