No More Plan B: Growth Kills the Fiscal Stimulus Debate in the UK

The return of growth in Britain means the debate has moved into a new phase. The argument that has, often tediously, dominated over three years – whether or not George Osborne should abandon his deficit-reduction strategy and have a “Plan B” fiscal stimulus – now looks dead and buried.

I shall return to that in a moment, and I will return to the debate about whether Mark Carney’s Bank of England can or should keep interest rates low as the upturn gathers momentum has heated up.

First let me talk about growth. People may not realise how strong recent numbers have been, particularly surveys. The purchasing managers’ index (PMI) showed manufacturing output rising at its fastest since July 1994, and orders at their most rapid since August that year. Britain’s factories “are booming again” said Rob Dobson of Markit, which compiles the data.

The equivalent survey for construction, responsible more than any other sector for reducing growth last year, showed the fastest rise in construction output since September 2007. Construction, lifted initially by housebuilding, appears to be enjoying a broad-based recovery.

You cannot have a modern-day recovery without the service sector playing its part. Fortunately it is. Service sector activity in August rose at its sharpest pace since December 2006, with growth in new business its best for 16 years. It was, according to Markit, “a stellar performance”.

Adding these up gives an economy firing on all cylinders, with construction, manufacturing and services all growing, and at their fastest pace on record, or at least a record going back to 1998, when Markit’s composite PMI was first calculated.

The August surveys, which followed strong July readings, are consistent, say economists, with annual growth of 4% to 5% and a rise of at least 1% in gross domestic product in the third quarter (more than once expected for the whole of 2013), following 0.7% in the second.

Whether or not the Office for National Statistics endorses this, we shall see. Official industrial production and trade figures for July, released on Friday, were a touch disappointing. But the Paris-based Organisation for Economic Co-operation and Development sees 0.9% third quarter growth and and 0.8% in the fourth.

This will be the strongest period of sustained growth since the crisis, and is supported by other evidence. Retail sales and new car registrations are up, the latter for the 18th month in a row. Britain’s exporters have improved their performance and business investment is picking up. The economy has got back its mojo.

Why is it happening, and can it last? The absence of new crises, particularly the eurozone, has boosted business and consumer confidence. What I call the “sod it” factor and others would describe as the delayed effects of exceptionally stimulative monetary policy, is boosting spending. As long as these conditions hold, this stronger recovery will persist.

The effect, as I say, has been to kill the argument for a fiscal U-turn by Osborne. The International Monetary Fund, whose chief economist was among those urging a such a shift, now sees global recovery as being driven by advanced economies such as Britain, echoing last week’s piece.

Its briefing for the Russian G20 meeting, describing what governments should be doing on deficits – sticking to the plan but allowing so-called automatic stabilizers to operate – sums up Britain’s approach.

The argument for a fiscal stimulus in Britain always suffered from serious shortcomings. A country running its largest peacetime budget deficit and teetering on the edge of an extreme fiscal crisis, had little option in practice but to pursue a credible strategy for reducing borrowing.

Not only that, but within that deficit-reduction strategy, government spending has been supportive of recovery. Between the second quarters of 2010 and 2013, government current spending rose by 4.4% in real terms to £88bn (in 2010) prices, significantly faster than the rise in GDP.

Capital spending by government, infrastructure, has fallen but less than most people think. In the second quarter of this year it was £8.4 billion (in 2010 prices), less than £500m below its level three years earlier. The argument that weak growth was due to “the cuts” does not hold water.

One response to the stronger growth now, and you hear this from Ed Balls, the shadow chancellor, is that it barely compensates for three years of “flatlining”
That overstates it. The economy has grown under the coalition, by a little over 1% a year if you exclude the distorting effects of much weaker North Sea oil production, by a little under 1% if you include it. Employment has been strong.

The trouble with fiscal policy to achieve stronger growth than that is that it rarely gets its timing right. Infrastructure spending cannot be switched on and off at will. Had Osborne been persuaded the infrastructure cuts he inherited from Labour were a mistake and should be reversed, we might just be seeing some extra spending coming through now, just when momentum is building without it.

Infrastructure spending is needed. But as Sir John Armitt pointed out last week, echoing the LSE Growth Commission, it is for the long-term, and should be taken out of short-term political decisions by establishing an infrastructure commission. It is not a short-term fiscal fix. Given the experience of government with big projects, it can be a great way of wasting money for limited economic benefit.

The fiscal stimulus crowd will not lie down quietly. Lord Skidelsky, Keynes’s biographer, will no doubt continue to argue what he sees as his master’s case.

But as long as this stronger growth persists, the stimulus crowd will dwindle, leaving just a few like those Japanese soldiers encountered on Pacific islands in the years after 1945, still fighting the last war.

What about stronger growth and forward guidance? Will it not scupper Carney’s hopes of keeping rates low?

This is the wrong way of looking at it. Low rates, and the commitment to keep them low until recovery is well-established, are a means to an end, not an end in themselves If sustained growth is achieved sooner rather than later, and if forward guidance helped, nobody would be happier than the new governor.

This piece is cross-posted from Economics UK with permission.