The Austerity Fairy

Today I’ve been playing with the greatest toy ever created. It’s not a Sony Playstation and it’s not a Pokemon. It’s a Rubik’s Cube.

The Problem

The Problem

One of the things that makes a Rubik’s Cube so great is that the problem you are trying to solve is very easy to understand. From the time you first picked one up, you understood exactly what you had to do – arrange it such that each face of the cube was the same colour.

The Solution

The very best people in the world have solved it in under 10 seconds, putting through around 5 moves per second.

I’ve just tried making 5 moves per second and I couldn’t even get close.

Let’s imagine taking someone who could move the cube this fast but didn’t know what they were aiming at, that is they know there is a single arrangement of the cube they are aiming for but don’t know what it is so they need to try every possible permutation.¬†I done a sum and by my reckoning, assuming they were able to go at 5 moves per second and were able to keep track of every permutation they had tried so that they never hit the same one twice, it would take them around 274 billion years to get through them all and be sure to have hit the solution.

6 seconds vs 274 billion years – the importance of understanding the problem you are trying to solve.

So anyway, the economy is shrinking again – down 0.2% in the final quarter of 2011 ūüė¶

George Osborne was not worried though:

We have the right plan and we’re going to stick with it!

In fairness to him he was half-right. We are going to stick with it.

George thinks the problem is spending. He thinks that as long as we spend less, at some stage the Austerity Fairy will show up and magic the economy back to health.

He blamed firstly, the reckless spending of the Labour government. Let’s get this one out of the way quickly with the IMF data I’ve put on here before. Between 1997 when Labour came to power and 2007, the year before financial meltdown, the UK’s debt as a proportion of its GDP was the lowest in the G7. In every single year:

Government debt as a percentage of GDP (Source IMF)

Government debt as a percentage of GDP (Source IMF)

Yes, the UK is the orange line at the bottom.

Next he blamed Europe. Wait a moment – is that the same Europe who are also awaiting the arrival of the Austerity Fairy? How’s that working out for them? Oh.

Much as George would like it, it’s actually not all everyone else’s fault. The reason George has not solved the problem is because, like the poor bugger spending eternity on a Rubik’s Cube he doesn’t understand the problem he is trying to solve.

The problem isn’t that we currently have too much spending. The problem is a lack of growth and high unemployment. Let me explain further.

In normal economic times when employment is high, if the economy starts looking a little shaky the Bank of England can cut interest rates. Lower interest rates make people want to save less money and spend more. When people spend more the economy picks up. Even Robert Peston knows that.

We are not in normal economic times though. Interest rates have been at an all time low for almost three years and you know what? No one is spending. For the rising number of unemployed this is understandable but for the people who kept their jobs why would they be saving more and spending less with such low interest rates?

It’s fairly simple. In an economic depression, even those people with jobs are scared that they might not have jobs at some time in the not so distant future. What would happen if they were made unemployed? Probably they wouldn’t walk straight into another job so they save. Even with crappy interest rates they save.

We have reduced interest rates pretty much as far as they can go but have still not got people spending again and we have therefore become stuck in something that economists call a liquidity trap. We have nowhere to go with interest rates so as long as the economy is weak no one will spend and as long as no one will spend, the economy will be weak.

This is the problem. Understand that much and the solution is a bit easier to grasp – you plug the gap with government spending until employment goes back up to healthy levels and people are spending again. When people are spending again, then you reduce it.

Even if George were able to grasp the economic problem, it would lead immediately him to a political one. How would he possibly explain to the public that for the past 20 months he had pursued exactly the opposite strategy of the one he should have? It would be political suicide. He’s not going to do that.

Better to take David by the hand and skip off together down the road to nowhere in search of the Austerity Fairy.

RedEaredRabbit