'Too far and too fast' or too little, too late? Why Osborne needs a plan B

Ed Miliband is taking the line that the coalition is cutting “too far and too fast”. The news that the economy shrank by 0.5% in Q4 of 2010 (zero growth if you factor in the adverse weather) is feeding speculation that the government’s cuts are endangering the economic recovery.

These growth figures should of course be viewed with caution as they are subject to revision. That said, the claim that the coalition’s planned spending cuts are responsible for last quarter’s GDP contraction simply does not stand up to scrutiny. Public spending in Q4 2010 was 5% higher than in Q4 2009 and was the highest spending in the month of December on public record. The government’s very modest reductions in spending begin in the next financial year.

George Osborne has remained defiant that the coalition’s programme of cuts must be maintained and that there is ‘no plan B’. This may be the minimum approach needed to ensure that the markets remain confident that there is a credible plan to eliminate the UK’s enormous budget deficit. Osborne’s critics are at pains to stress that there should be a plan B and I happen to agree. But Plan B should be cutting spending further in order to reverse tax hikes which are damaging private businesses. For example, the coalition’s policy of ring-fencing the NHS and international aid should be reconsidered given that these areas account for nearly a third of government spending. Reversing the counterproductive rises in Capital Gains Tax and VAT must be a priority, while the incentive-destroying 50p income tax rate on top-earners should be reduced at the earliest opportunity.

The line that the government is cutting ‘too far and too fast’ may appeal to the public at large - if Labour’s poll ratings are anything to go by - but in reality continuing high levels of government spending are hampering growth by crowding out the productive private sector. The coalition must reduce spending further and faster if it wants individuals and businesses to prosper.

It is correct to highlight the point about ring-fencing budgets in the two departments mentioned. Today we have learned that DFID paid £1.8m last year to cover the costs of a State visit by the Pope. Needless re-organisation costs in the NHS is another area of totally unnecessary public expense. Lack of access to capital amongst small and medium enterprises is a much larger barrier to growth and risk to the economy and its recovery than public sector "crowding out". Would the 2400 employees of Pfizer or local councils agree with that statement too? The Prime Minister was at a public presentation a short time ago, singing the praises of Pfizer. Pfizer was instrumental in stimulating growth in the economy in the East of Kent over the last 20 years. The people that work there are highly qualified, high value-added research and development professionals. Exactly the type of jobs we desperately need in the UK. Local and national politicians should have seen the writing on the wall, when the decision to stop manufacturing there happened a couple of years ago. If I were Cameron, Clegg, Osborne, Cable and Willetts, I would be much more concerned about this Pfizer decision, than about how much more self-flagalation the public sector can do by way of cuts. As mentioned here before the banks could allocate the £7bn bonus pool, along with at least a parallel amount of their own resources into a large innovation fund to support the development of new enterprise. Pfizer's R&D site at Sandwich could and should be one of the first beneficiaries. The site should be used to create a series of "biotech" buy out companies, each focused on different areas of drug research. If Cameron does not get any progress from the banks by speaking to them, then he needs to find somebody to bang their heads together, and fast.

Jonathan - why should the government decide how the site at Sandwich should be used? As Mises put it, politicians and bureaucrats lack the 'commercial mindedness' of entrepreneurs. Government has a dreadful record of failure when it comes to 'picking winners'.

Richard - You have jumped to the wrong conclusion. Nowhere does it say that the government should be "picking winners". The private sector should take the lead. You will recall that the private sector, in particular the banking and finance profession failed to take the lead when the future of Cadburys was at stake. The City could have financed a UK restructuring or buyout, etc. The future of Sandwich should be led by entrepreneurs and financed by banks, as stated above. The state will become involved in one of two ways, either picking up the pieces from all the shattered lives; redundancies, potentially mothballed site, paying unemployment benefits for years to come, followed by the local economic and social consequences of this, i.e. reactively. I am not sure how the "Big Society" fits into that. Or it takes positive action, proactively. So, is the glass half-full or half-empty? What do you want: stagnation and depression, or turnaround and growth? This particular case could be cataclismic or catalytic, which should it to be? Ludwig von Mises died in 1973. I think that you owe it to him to learn the lessons of the 1980s and 1990s recessions and the recent credit crunch and recession, especially in the UK. Sadly he was not around to do so or to either clarify, adapt and change his views and commentary, or correct the misinterpretations by those who would fundamentally and anarchically take his name in vain today.
Richard von Mises believed in the following: "(a) that the expansion of free markets, the division of labor, and private capital investment is the only possible path to the prosperity and flourishing of the human race;" By creating multiple spin off companies from Pfizer at the site, free markets are being expanded, private capital investment is forthcoming from the banks and those people that work there will flourish and grow. The recessionary resolution of market restructuring is being accelerated in the process, another Misesian concept followed through. So, just what is the problem with my earlier suggestions about the Pfizer site?
An interesting quote from von Mises, from his "Theory and History". "Only stilted pedants can conceive the idea that there are absolute norms to tell what is beautiful and what is not. They try to derive from the works of the past a code of rules with which, as they fancy, the writers and artists of the future should comply. But the genius does not cooperate with the pundit."

Jonathan - What kind of 'positive action' do you think the state should be taking proactively? I don't think it is entirely clear from your comments. Moreover, will the banks be forced by government to allocate their bonus pool into the innovation fund rather than paying it to staff? And, why, if the new enterprises you mention are such good investments, won't the banks/venture capitalists/private investors invest in them in the normal way?

Richard - Its a real shame that von Mises is not about today, having had personal experience of the banking profession. He may well have had useful insights to bring to today and how to change the banking industry for the better. It would have been good to get his thoughts on the impact of the global petroleum industry also on his theories of economic cycles. Sadly, he died too early to analyse even alone the 1970s oil price shock, never mind the inflationary spike in prices in 2007/8. You have probably read elsewhere that in his Theory of the Economic cycle von Mises blamed the banks for the limitless ability to create credit, as the major cause of booms and excess and the types of lending practices which inevitably lead to the busts. If you take his analysis as being correct, then there remains the option for the state to redefine the level of freedom that banks have to operate in the creation of credit. All the banks have a licence to operate from the state and there are laws designed to prevent usuary and financial fraud, as these are seen as for the greater good of society in developed liberal democracies. So if you take into account the ability of the state to act to prevent crime, fraud and usuary, as well as the parameters for banking licences, then it does not take a huge step in belief to understand that the state can adjust and alter those boundaries from time to time in support of the general good. It has been well documented that the banks have not been providing enough finance, at reasonable rates to small and medium companies to enable them to grow, expand and create jobs in the economy; the Engineering Employers Federation and British Chambers of Commerce and the Confederation of British Industry have all gone on record to this effect. The Bank of England's regular financial markets reviews suggest this too. On the one hand the banks have the funds to pay £8bn in bonuses, whilst other employees continue to be made redundant, suffer pay freezes and cuts, but on the other hand there are not enough funds available to businesses at a reasonable rate, arguably even to consumers too for house purchases. This bank capital could be allocated to invest in companies. Unless capital allocation favours the development of the economy as a whole, not just banks and their employees, rather than accelerating the restructuring of that industry that von Mises would have advocated, were he alive then the recession and possible depression will be extended. This would be contrary to a von Misesian interpretation of the current economic situation and particularly the banking sector.

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