Where we are

When Chancellor, Gordon Brown talked about fiscal responsibility "balancing the budget over the economic cycle". About "borrowing for investment". Unfortunately he failed to recognise where he was in an economic cycle. Instead of prudently cutting expenditure and putting money away during the boom, he continued to spend as if the economy was in a slump. He was believing the myth that he had "abolished boom and bust" and he believed that his new economics meant there would always be plenty of money later to pay the bills he was racking up today.

Brown was fundamentally wrong. So when a REAL slump arrived his treasury was in no state to help the people weather it. Revenues fell and there was no money left to spend (the famous note left on a treasury desk after the election!). What was worse, the slump took the form of a banking crisis. The UK has the second largest banking sector in the world, so we were hit particularly hard. We had to bail out a number of banks and that required the government to borrow yet more money.

Now, the Labour opposition, the same people who got the economy into this mess by spending too much, say the only way out is to spend more. If they had left a little extra in the kitty that would be true, but as they didn't the option is not available.

The truth is, the economic situation is really bad. Demand is down, because : (1) Past demand was fuelled by personal borrowing (mortgages, credit cards). So with no appetite for taking on more debt, personal expenditure must fall to personal income. (2) people need to pay off those debts, so a proportion of their income is just going straight back to the banks. (3) the slump means unemployment, wage freezes or cuts, benefit cuts so again less income to spend. With lower demand, business is forced to cut back and that in turn leads to more unemployment et.c which further depresses demand.

So how do we get out if this? Traditionally we could aim for an export led recovery, but over the past 40years we've relentlessly closed or sold our exporting industries. We no longer export steel, ships, aircraft, trains, generators, cloth, you name it we don't make it. And our main export markets, the EU and USA, are also in a slump and not buying what they did. Labour would like to see us invest in public works. They argue that would take people off the dole and start paying tax. Trouble is, only part of the cost of public works goes to wages and only a part of that returns to the treasury. Quite a lot could go to imported raw materials and machinery so the net impact would still be negative. And government debt would climb yet further..

Perhaps if the pound were to fall against other currencies we could inflate out way out of debt. Everyone with sterling denominated savings would lose out and as a country we would get poorer, but our export prospects would improve and the value of our sterling debt would fall. Unfortunately the world won't let us off the hook that way, other major currencies have the same problem.

So until someone comes up with a clever solution, we're stuffed. Only when deficit and debt are back to sustainable levels can we start to progress. Better get back to cutting spending. Meanwhile we need to get exporting, whatever investment is available needs to go to create and support export businesses, especially any business that can export to China.