Business | Opinion
UK's spending plan unlikely to bolster economic revival
This is a global recession. An extra few billion spent on roads or other public works won't make any difference.
- By Matthew Lynn, Bloomberg
- Published: 22:50 November 8, 2008
The British could be forgiven for feeling gloomy right now with a tumbling currency, a shrinking economy, rising unemployment and a financial system that needed a government bailout.
Still, help is at hand. The government is now planning to spend its way out of recession.
In the past week, Prime Minister Gordon Brown has made clear his response to the most serious economic decline the UK has faced in more than a generation.
In homage to economist John Maynard Keynes, Brown plans to spend and spend, casting aside his own rules on debt and launching big infrastructure projects. By stoking demand, the aim is to avert a long recession.
He will be disappointed. At best, the final splurge of government spending will prove to be irrelevant. At worst, it risks turning a bad situation into a catastrophe.
The UK depends on the global capital markets to stay afloat. Scare away international investors and the country could turn very quickly into anther Iceland. There is no doubt the UK is slipping into deep trouble.
"The prospects for the UK economy are grim, with a fairly severe recession starting to unfold,'' Michael Saunders, an economist at Citigroup Inc. in London, said in a note to investors last month.
He predicts the economy will contract by one per cent next year. On Friday, the European Commission made the same forecast.
Arbitrary Rules
The government is getting out its chequebook. Last week, Chancellor of the Exchequer Alistair Darling said the rule that limits public debt to less than 40 per cent of gross domestic product would be waived. "To apply these rules rigidly in today's changed conditions would be perverse," he said.
Maybe so. But once you start picking and choosing when the rules apply, they aren't rules anymore. "The responsible course of action is more borrowing for the investment that is necessary both now and for the longer term," Brown said last week.
But is more spending really "responsible"?
Interest rates in the UK, at 4.5 per cent, higher than in the euro area and the US. There is still scope for monetary policy to stimulate demand.
There is no reason interest rates shouldn't be cut to one per cent, or lower if necessary. There's a case for a public-spending increase when borrowing costs are close to zero, and can't go any lower. Yet Britain is a long way from that point.
Next, people know that borrowing today has to be repaid tomorrow. That means taxes will soar. As debt levels rise, consumers and companies will save more to help pay for higher taxes down the track. Whatever boost you get from higher government spending will be lost.
Worse, all that extra spending will hurt the currency. The pound fell as low as $1.53 on October 24 compared with more than $2 earlier in the year.
The UK is dependent on foreign finance since it runs huge trade and public-sector deficits. If public finances spiral out of control, global investors may take flight, and bail out of sterling. If that happens, Britain could end up like Iceland. It is hardly a risk worth taking.
Finally, this is a global recession. The UK relies more than most countries on world trade, so it will be one of the most affected. An extra few billion pounds spent on roads or other public works won't make any difference.
The polls suggest many British have already seen through the arguments for more public spending. The Taxpayers' Alliance said a week ago in a poll that 59 per cent of voters would rather have lower taxes than higher public spending. Only 18 per cent wanted the government to increase its outlays.
The UK spent its way into trouble. It can't spend its way out again. Taxes have risen too high, and debt has soared out of control.
The nation needs to pay down its obligations and lessen its dependence on financial services. There is no reason it can't make that transition with hard work and some belt-tightening.
A final splurge of public spending will only postpone that adjustment and create a real risk of economic disaster.
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