11 Jul 2013 02:58pm

We need government to get the economy moving

I would describe the current economic situation in the UK as being a depression, not a recession. We are way below where we should be in productivity terms. But the low productivity in itself isn’t worrying. We could easily make it up if we got the economy moving. There is plenty of capacity in the workforce to help respond to the demand, if and when it comes. People in work might be under-employed, but keeping as many people in work as possible is good. The current economic problem is one of demand, not supply

But the government’s austerity policy isn’t helping, it’s adding to the problem. They’re making huge mistakes. When the Coalition came to power, there were signs of recovery, but it nipped recovery in the bud with its fiscal policy. Increasing VAT by 2.5% is similar to knocking 1% off GDP. It argued the rise was offset by low interest rates. The Office for Budget Responsibility forecast growth from 2010 onwards, only for it to disappear. The Coalition effectively put an end to the good work Gordon Brown had done.

There were signs of recovery, but the Coalition nipped it in the bud with its fiscal policy

World trade was collapsing at a rate of 20% a year in the closing months of 2008 and early 2009, and at the G20 summit in London in April 2009, Brown played a pivotal role in persuading leaders to inject an unprecedented $1.1trn into the IMF and World Bank, with a view to boosting liquidity and stabilising the global economy.

In his book Beyond the Crash, Brown noted the combination of that boost and other measures meant “we now know that a total of $3trn was injected into the budgets of national economies to take us out of recession”. This became known as “the stimulus”. Brown was being slated at home, but was admired and respected internationally for what he was doing, particularly for his insistence that the banks needed recapitalising.

Even Hu Jintao, the Chinese president, praised him for stopping the rot. A few months earlier, in October 2008, he announced the government would take a controlling interest in three major UK banks, prompting an invitation by then French president Sarkozy to join a meeting of eurozone ministers. “My friend Gordon has the right plan,” Sarkozy said, and Europe followed Britain’s example as, prompted by Brown, did the US.

Today, with the banks reluctant to lend, and interest rates failing to entice consumers to spend or businesses to invest more, we are in a fiscal squeeze. So, what needs to be done? With wages scarcely rising, the first thing should be to cut VAT to boost demand, especially as inflation isn’t a problem. It would reduce the retail price index, which would provide a boost to the economy.

Local authority cuts make the situation worse, leading to greater unemployment, less spending and more hardship. Serious discipline with public spending should wait until the economy is in recovery. It also makes sense to talk to the French, Italians and Spanish to come up with a plan for getting us out of depression. Austerity politics across southern Europe makes things worse. We are all in the EU. There are fears a unilateral move would be punished by the financial markets, but if there is no appetite for concerted action, the UK needs to go it alone. We should also look further afield for help. For a supposedly global economy, there is a severe lack of international co-ordination.

The Coalition decided to get the pain out of the way early, allowing the economy to boom in time for them to win the next election. That strategy has failed. There is no real sign of recovery despite lots of false dawns. The National Institute of Social and Economic Research described the economy last month as “depressed”. Output in the UK is 15% below what it would be had long-term trends continued. I have some sympathy with the idea that we had an artificial financial-services-induced peak in 2008 and are now in an artificial trough.

But we could get back on the growth trajectory faster than we are doing. Except for Greece, this was a banking crisis, not a fiscal crisis. While some like to claim the consumer boom under Brown was the reason for the crash, it was less pronounced than the Lawson boom in the 1980s. The crisis was caused by banks, not government. The solution lies with the government, if it adopts the right policy mix.

William Keegan William Keegan is senior economics commentator at The Observer and author of ‘Saving the World’? Gordon Brown Reconsidered (Searching Finance Ltd, October 2012)