Global Economy

Lord Eatwell Excerpts

Thursday 11th August 2011 Lords Chamber

[Lord Eatwell]

My Lords, I am most grateful to the noble Lord for repeating the Statement made by the Chancellor in the other place and for travelling back to the House to do so. We are living through a grave and difficult situation for the international economy; indeed, for the economy abroad and at home. Many noble Lords will feel that the current situation in the global economy is eerily reminiscent of the early days of the financial crisis in 2007-08. Then, as now, shocks to relatively small entities destabilised financial markets by undermining confidence in the authorities’ understanding of what was happening and hence their ability to do anything constructive. Small events then spread to even larger entities, so that even the most stable and secure institutions were affected. Then as now, fears were stoked up by the grandstanding of the ratings agencies. Then as now, funding dried up and the solvency of major institutions and sovereign states was questioned. Some of the actors have changed, but the play is the same, and those who will suffer—ordinary, hard-working people—remain the same too. As the crisis enters this new phase, are we better prepared? Have we learnt the lessons of the past three years? Does the Chancellor’s Statement represent a new understanding of what is happening?

The first lesson is simply to remember that the object of economic policy is the prosperity of our citizens, not the comfort of the financial markets. Stable financial markets are a means to an end, not an end in itself. That lesson was clearly learnt in the strategy devised by the G20 in 2009. It committed members to halve national deficits in five years by pursuing a concerted growth strategy. Unfortunately, the commitments made in 2009 were abandoned a year later. The growth strategy was abandoned in favour of austerity, imposed either by the markets, as in Greece, or by the Government, as in Britain.

The second lesson was the need for a clear analysis and understanding of what was happening in order to fashion an appropriate response and to generate confidence throughout the economy. Recent events in the United States and the eurozone suggest that this lesson has not been learnt. In the United States, the political wrangling of the past few months, and the intransigence and lack of flexibility of some senior policy-makers, resulted in a loss of confidence in the authorities' ability to deliver an economic recovery and even in their understanding of what needed to be done. None the less, at least output in the US has recovered to pre-crisis levels, while output in the UK is still 4 per cent below those levels. The Chancellor’s cheap jibe about US growth over the past two quarters is a fine example of statistical chicanery. Will the noble Lord explain why the US has got output back to pre-crisis levels but the UK has not?

In the eurozone, it should be clear to all that the institutions of monetary union are perfectly designed to transform economic difficulties into economic crises. The lack of a single eurobond market, backed by an effective treasury function and allied to fiscal transfers that occur as a matter of course in the US and the UK, results in a situation in which growth in weaker economic areas can result only in the accumulation of debt—and accumulation of debt results in the diversion of funding from the weak to the strong. It should be clear by now also that the main beneficiary of this flawed structure is Germany. We can imagine where the German exchange rate would be if it were the outcome of a deutschmark market rather than a euro market. Germany would be being priced out of world markets by its own exchange rate. What would happen to German export-led growth then? Does not the greatest beneficiary have the greatest responsibility to secure positive reform for every nation in the eurozone? Given the importance of the eurozone to the UK economy, we should do everything we can to assist in the creation of institutions necessary to run a successful monetary union. Here, I agree with the Chancellor's assessment of what reforms need to be made. The process will almost certainly require significant revision to European treaties. Will the Government lend their support to treaty revision?

The third lesson that is becoming clearer every day is that austerity alone does not work. The Chancellor has persistently argued that the Government’s austerity policy will, in and of itself, promote confidence in business to invest and in households to consume, thereby rebalancing the economy. Chart 2.7 of the Bank of England’s Inflation Report, published yesterday, shows clearly that the Government will meet their deficit targets only if firms and households start borrowing and spending again—if they borrow to replace government borrowing. However, that is not happening. The austerity policy is not working. Households are saving and companies are not investing. Financial institutions are deleveraging. Growth in manufacturing has ground to a halt and the balance of payments deficit is on the rise again. Real incomes are falling, squeezed by the rise in VAT and by an inflation rate that is twice as high as in France or Germany. The economy is dead in the water, yet the Chancellor’s Statement shows no recognition of what is happening out there in the real world. He repeats his obsession with deficit reduction at the cost of economic growth.

The central message of the Statement is that bond rates are low and the ratings agencies are appeased. But has anyone in the Government noticed that exactly the same was true in the Japanese economy 20 years ago, and has been for the past 20 years? Interest rates in Japan are significantly lower than in the UK, and have been for 20 years, and Japan’s AAA rating is secure. The result is 20 years of stagnation, “lost decades” as they are called, and the Japanese deficit has not fallen. We risk the same fate. Already, with prospective growth in the UK being downgraded by every respected economic agency, the deficit forecast is rising, not falling. The crisis in the financial markets has shifted from fears about deficits to fears about stagnation. The markets have realised that austerity will not fix deficits. Austerity reduces tax revenues and forces the Government into yet further expenditure cuts to hit its deficit targets.

There is no recognition of these dangers in the Statement, and they are dangers not only for Britain but for the global economy, as the obsession with austerity grips policy-makers around the world. Britain’s lead in this respect is doing great damage. What is needed now is a strategy for growth—in the United States; in the eurozone as a whole, not just in the northern states; and in the UK. The Chancellor recognises this and states that Britain needs a new model for growth. We on this side agree, but the plan for growth trumpeted by the Government—and who would not discount a plan that is described as “83 initiatives” rather than having clear content and direction?— was assessed by the independent Office for Budget Responsibility and its conclusion was that it would have no significant impact on growth at all.

What new measures do the Government have in mind to stimulate growth? Now is the time for the Government to back a real growth initiative, one based on investment in infrastructure, productive capacity, skills and new technologies. It should include an accelerated infrastructure programme, a national investment bank to mobilise funds lying idle in corporate balance sheets, and greater incentives for investment in and the expansion of new technologies. Without a commitment to economic growth, confidence will not return to industry or the consumer and deficit targets will not be met.

Policy-makers around the world, most especially the British Government, need to learn the bitter lessons of the last three years—that the object of economic policy is the prosperity of our citizens, not the comfort of financial markets; that a clear and consistent understanding of what is happening is necessary; and that austerity alone does not work. Simply repeating over and again that a policy is working does not make it true. The Government’s austerity policy is not working. It may delight the Chancellor’s friends in the ratings agencies, but it means prolonged stagnation for the British economy and economic misery for the British people. The Government need to face up to the reality of what is happening in the British economy and introduce a truly substantial growth strategy now.