Pearlstein: A blot on Britain’s jubilee

Steven Pearlstein
Columnist June 2, 2012

When it comes to pomp and ceremony, nobody does it better than the British, and this weekend they’ll be wallowing in it as Queen Elizabeth marks her 60th year on the throne with concerts, parades and a royal flotilla down the Thames.

Steven Pearlstein is a business and economics columnist who writes about local, national and international topics. View Archive

But the ghost that hangs over the British economy these days is not that of the queen but of her least favorite prime minister, Margaret Thatcher, whose stubborn refusal to budge from her program of fiscal austerity in the face of a deepening recession 30 years ago still animates the policies of her Tory successors.

“The lady’s not for turning,” Thatcher famously declared to the Tory faithful in response to calls for a “U-turn” of her plans for budget cutting and privatization. Now, as the British economy, along with the rest of Europe, slides back into recession and financial crisis, Prime Minister David Cameron is determined to appear equally steadfast in his determination to reduce the deficit and pare back a government that had swelled to 50 percent of gross domestic product under 17 years of Labor rule.

In economic terms, the austerity debate here, as in the United States, has become as silly as it is stale.

With a relatively high debt level and credit markets increasingly wary, Britain probably had no choice in 2010 but to embark on a credible program to reduce a cyclically adjusted structural deficit that had grown to 6 percent of GDP.

But to argue that this has now driven the British economy back into recession is an unconvincing stretch. Most of the cuts have yet to take place, fiscal stimulus this year is still in excess of 8 percent of GDP and the Bank of England has embarked on yet another round of monetary stimulus. If the recovery here has stalled, it is primarily the result of rising energy prices and the financial and economic crisis in Europe, which accounts for 60 percent of British exports.

One puzzle is that even as the economic growth, as measured by GDP, seems to have stalled and the government begins to shrink, the private sector has continued to create jobs. These include low-end service jobs in London’s restaurants and hotels, every one of which seems to have been filled almost exclusively with hard-working and well-spoken Eastern Europeans; blue-collar jobs in a manufacturing sector long since given up for dead; and — here’s the biggest surprise — even more new jobs in a financial sector that remains the vital engine of an export-oriented cluster that includes bankers, insurers, money managers, lawyers, consultants, marketers, headhunters and even journalists.

Indeed, there is a suspicion that at least some of the downturn here is a statistical mirage caused by the necessary adjustment to wages and prices following the bursting of that financial bubble. If the financial sector never really added as much genuine value to the economy as was indicated from all those inflated salaries and bonuses, then at least some of the decline in GDP since then may merely reflect a healthy repricing of labor, financial assets and goods across the economy rather than a worrisome loss of output. Low inflation, slowly rising employment, little or no growth in measured productivity, household incomes and GDP — these are all consistent with that story of statistical mirage.

If the government’s “austerity” program is not the major culprit in the recent slowdown, however, it is becoming equally obvious that only pride and political pig-headedness prevent the Cameron government from making the badly needed investments that would help to alleviate it. That’s not only the developing consensus among economists and business leaders I spoke with, but also that of the European Union and the International Monetary Fund.

Other than Labor Party politicians, nobody seriously doubts the wisdom of cutting back on the number of public employees or the size of their pensions, or capping welfare payments to any household at the median income, or bringing more efficiency to public education or the public health service through greater competition. The idea that these will be done once the economy returns to normal growth is a political fantasy.

But having established its fiscal and political credibility with financial markets through these structural reforms, it borders on folly for the government not to cash in on some of that credibility by finding a way to combine private capital with additional government borrowing to build a much-needed new airport for London near the mouth of the Thames, widen two-lane roads that now routinely bring traffic to a standstill and build 3 million desperately needed housing units in a market where prices have been pushed up to absurd levels by overpaid hedge fund managers and no-growth local planning commissions.

The argument against these targeted investments is that market credibility is a hard-won prize and that any hint that the government might be wavering on its debt-reduction commitments would jeopardize it.

“Either you believe in rigor or you don’t,” said one top British industry leader.

There are three problems with this logic.

One is that the government has already retreated on its initial plan in lots of small ways, like last week’s announcement by George Osborne, the posh chancellor of the exchequer, that he had withdrawn his proposal for higher sales taxes on blue-collar favorites such as vacation “caravans” and those hot savory pastries — known as “pasties” — sold by street vendors.

Indeed, as Jonathan Portes, director of the National Institute of Economic and Social Research points out, Osborne has already abandoned his original argument that austerity will so bolster consumer and business confidence that it will boost economic growth. His new, more defensive posture is that it won’t detract much from growth.

More to the point, if budget deficits are what you care about, the lack of growth turns out to be an outsize problem given the structure of government finance, with its long debt maturities and heavy reliance on income and sales taxes. Deficits are many times more sensitive to changes in growth rates than to changes in government borrowing rates. For that reason, the government has already acknowledged — with no obvious impact on market confidence — that it will take two years longer than projected to reach its deficit reduction target.

Surely one big reason there has been no impact is that attracting capital, it turns out, is a relative game. Like U.S. Treasurys, British “gilts” have been the beneficiaries of investor flight from Greek, Spanish, Portuguese, Italian and Irish bonds, with rates falling three quarters of a percentage point over the past few months. By any reasonable economic calculation, that ought to give the Cameron government the financial headroom for additional borrowing and investing as long as it holds fast to its structural reforms.

If the economic logic for a change in policy was not compelling enough, you’d think the political logic would be, particularly given the sharp drop in the approval rating for the Cameron government as a result of the slowdown. But apparently that’s not the way it looks through the warped looking-glass of British politics. Anything that smacks of a U-turn on the party’s signature issue might be seen as an un-Thatcher-like sign of weakness, a blow to the pride and vanity of the prime minister and his chancellor, a threat to unity of a conservative party split between pragmatists and ideologues, a victory not for the country or the economy but for the opposition party.

Come to think of it, after you strip away the royal barges and the horse-drawn carriages, it looks and sounds just like American politics.

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