Economic Insanity

Earlier this week I wrote the short story, George’s Magical Mystery Tour, in which a bus driver called George refused to acknowledge the reason that his bus wouldn’t get up a hill, preferring instead to implement superficial changes to his bus in order to make it look like he was doing something.

Some of you may have spotted the subtle metaphor in my story. I was in fact making a hugely clever reference to the economy and the budget. So metaphor aside, why do I think this budget was so bad?

Let’s quickly recap the problem that we should be trying to solve. The UK is experiencing an economic depression. This means that the economy is operating significantly below potential for a sustained period without any sign of recovery.

Now you’d think that having presided over a depression that has already gone on significantly longer than the Great Depression of the 1930s this budget would be all about restoring growth. You’d think that but it wasn’t. In fact there was pretty much nothing in there at all that even attempted economic growth.

As the OBR pointed out in their budget report:

The Government has announced a number of policy measures that are expected to have a broadly neutral fiscal impact in aggregate between 2012-13 and 2017-18, with ‘giveaways’ almost exactly offsetting ‘takeaways’ over this period. Correspondingly, we also assume that they will have a broadly neutral effect on the economy, with no impact on the level of GDP at the end of the forecast horizon.

It seems incomprehensible but it really is the case. The government chose to implement a budget that would have no overall effect on economic growth.

That’s not to say it was entirely made up of bad ideas. The raising of the personal allowance to £10,000 will help out low earners and will increase economic growth because a large part of the extra cash in their pockets will be spent. It’s a very small amount though. The OBR forecast an effect on GDP of less than 0.1% and that, they pointed out, would be offset by other GDP reducing elements of the budget in any case.

Another good idea is giving tax breaks for child care. Lowering the cost of child care makes it more attractive for parents to work rather than stay at home looking after the kids themselves. However, at the moment the economy is suffering from a lack of jobs rather than a lack of people who want to work. Increasing the number of people who want to work will have a positive effect when the economy starts to recover but won’t do much to effect that recovery.

There was also a mind-numbingly bad idea in there called the Help to Buy scheme, which as Jonathan Portes from NIESR points out is nothing more than a taxpayer funded bank subsidy:

The government will offer banks a guarantee on high loan-to-value mortgages – mortgages for between 80% and 95% of property value – on existing as well as new houses, both for new borrowers and those wishing to refinance. If a borrower defaults, the first loss will fall not on the bank that made the loan, but on the taxpayer. And it is for banks to decide which of the qualifying mortgages they want to keep and which they think are sufficiently risky that they want to pass the first slice of credit risk on to taxpayers.

The economic rationale for designing a mortgage market intervention in this way is almost impossible to understand. There are well-known market failures in both the retail and wholesale markets for mortgages, so there’s plenty of scope for radical reform. But, instead of explaining what problem it is trying to solve and how, the Treasury has created yet another subsidy for banks. Worse still, the structure of the subsidy will weaken competition even further by propping up incumbent banks and perpetuating an unreconstructed housing finance market with fundamental weaknesses.

A bad economic idea from George Osborne is hardly big news these days though and although this one is particularly bad there was something far worse in the budget. Although no effort had been made in putting any sensible growth strategy in place, there was clearly a huge effort put into dodgy accounting tricks to make the deficit look smaller than it really is. Tim Harford does an excellent job of breaking that down here.

This really is the political equivalent of telling people that you’re cooking them a slap-up Sunday roast and then placing a small parsley sprig on top of some putrified road-kill. For George Osborne it is clearly the priority to put all efforts into making a failed strategy appear less of a failure than it really is, rather than diverting any effort into actually addressing the underlying problem.

Economically this is pure insanity – a budget that makes no attempt to move things in the right direction and every attempt to use every accounting fiddle to make it look like it actually is.

It’s abundantly clear that the government are now pinning all hopes on the economy just sorting itself out on its own. In spite of their policies that will happen one day but why not do something to make that day come sooner? Or more to the point, why didn’t they do it three years ago?

To be honest, after three years, I don’t know why this stuff still surprises me. Politically astute, economically insane – welcome to the UK.


George’s Magical Mystery Tour

One day a bus driver, we’ll call him George, was driving a bus full of people up a steep hill but unfortunately his bus had a broken engine.

George had taken on driver duties near the bottom of the hill when the fault with the engine was already in place – as George liked to point out, it had developed under the previous bus driver.

George had known about the fault from the start but had told his passengers it would go away in time if he just kept on driving. Unfortunately driving on in the same way with a busted engine had made the engine fault worse. Progress was sluggish at first but for the past two years the bus had remained static – the failing engine doing just enough to prevent the bus rolling back down the hill into oblivion but not enough to move it any further forward up the hill.

When George first took on bus driver duties many of the passengers were willing to believe his assurances that driving along with a busted engine was better than fixing it but having spent two years looking out of the windows at the same depressing scenery they had reached the point of mutiny.

And so in March 2013, George addressed his passengers:

To get this bus up the hill, we will start by washing the windows – the weight of that dirt is clearly hampering our progress. Additionally we will paint go-faster stripes on the side of the bus. We will follow this up by cutting the price of the journey for the people in the posh seats at the front, which will by magic, generate more money – money that we will use to fit a big spoiler to the back of the bus to make it look like it’s a fast bus, thereby giving you all confidence that we will get up the hill.

The passengers were not convinced.

But what about the, erm… you know, the problem with the engine?

The problem with the engine was inherited from the previous bus driver.

Ok, but you do seem to have made it worse and anyway, even if it were all the previous bus driver’s fault shouldn’t we, you know.. fix it anyway? You know… in the interest of getting up this hill?

George pretended not to hear and gunned the engine some more. It made a sickly, spluttering sound.

He pretended not to hear that too.


When Markets Don’t Attack

As I wrote recently, last week was going to be the real test of whether George Osborne’s policy of pursuing a AAA credit rating above all else was justified. Although he lost that rating anyway we would at least see whether, as he’d repeatedly warned us, the rate at which the government can borrow money would go through the roof as the markets lost all that “hard-won confidence”.

He has continually used this threat to justify austerity so it’s important to see whether or not there was any merit in his argument. So let’s see what happened to our borrowing rates last week. Make sure you have a cushion ready to hide your face, this is going to be scary:

Rates on 10Y UK Government Bonds

Rates on 10Y UK Government Bonds

It’s ok, you can put the cushion down now – nothing happened. I told it wouldn’t but how could I be so sure? Am I a soothsayer? Am I the modern day Nostradamus? No, not at all. I took the revolutionary step of applying the discipline of economics to the situation.

The government seems to believe that economics and evidence are dangerous things because they might encourage people to look for an alternative to their failed policy. The thing is though, that over the last three years economics has done a much better job of predicting these sort of things than a government who chose to ignore it. While far from perfect, economics is still the best tool we have to help guide our way back towards a healthy economy.

At the moment though we have a government who dismisses economics as if it were witchcraft and why is that? Because it’s simply more convenient than admitting that they got everything so massively wrong.