Duncan’s Economic Blog

Dividing Lines & Economic Policy

Posted in Uncategorized by duncanseconomicblog on December 4, 2009

The newspapers this morning have put me in a very good mood. The front page of the FT leads with two stories. First we have ‘RBS sound retreat of big bonuses’.

Royal Bank of Scotland has signalled that it will succumb to pressure to pay its high-flying investment bankers substantially less than rival institutions amid an escalating row with the government.

The bank, which is 70 per cent owned by taxpayers, is hoping to avoid a high-stakes showdown after it was forced to give the Treasury the final say over the total size of its bonus pool as a condition of signing up to a scheme that will insure £240bn in toxic assets.

RBS insiders insisted on Thursday that pay-outs in its investment banking division would be “at the low, low end of the scale”, even if that meant losing experienced staff to competitors.

The most interesting story though is ‘Darling to defer moves to cut deficit’:

Alistair Darling will next week set out a pre-Budget report that will increase taxes on the wealthy and funnel scarce resources into boosting the economy, while deferring tough new measures to cut Britain’s £175bn deficit.

Mr Darling will argue that a further squeeze on spending now would choke the recovery, contrasting with the Tories who have promised to move more quickly to control borrowing.

A fiscal responsibility bill will be published setting out detailed provisions to cut the deficit to 5.5 per cent by 2014, and giving details of how the chancellor arrives at his forecasts, to boost their credibility in the markets.

Darling is completely correct as this blog as argued for months. The dividing lines are becoming clear. Martin Wolf’s excellent column on the UK economy today offers support:

The path of least resistance on growth would be the desperate hope that a wave of loose monetary policies across the globe would allow a resurgent, but largely unreformed, financial sector to refloat the UK economy. That would be dangerous, economically (because unstable) and fiscally (because potentially costly). The UK can barely afford to insure its current financial sector, let alone one even bigger.

This is basically the Tory position, as advocated by Osborne – a reliance on loose monetary policy:

What we call for is a credible plan to eliminate the deficit that commands international and domestic confidence, and that moves more quickly and decisively than the government to deal with the deficit.

For tightening fiscal policy as the recovery gathers pace will help prolong the low interest rates that are doing so much to cushion the impact of the recession and bring about a recovery

 Wolf, having condemned Tory plans, continues, with his ideal solution:

The solution must be found elsewhere: in a growth-oriented policy that encourages emergence of a more diversified economy. This should be done not by suppressing markets, but by supporting and guiding them. Fiscal cutbacks must not fall on activities likely to support growth – infrastructure and research and development. Both savings and investment will need to rise. Immigration policy should seek those most able to contribute. In view of the household indebtedness, attention should go to activities that serve world markets.

Which is the policy that Darling is adopting – a growth-oriented policy of support for the economy. Mandelson’s interview in today’s Guardian only reinforces this:

He wants the government to do more to support hi-tech industries such as biosciences, digital and low carbon manufacturers (which include everyone from reactor suppliers to builders of wind farms).

“I’m unashamedly talking about the reindustrialisation of the British economy, but not by going back to the old smokestack manufacturing past – we know we can’t turn the clock back,” he says. If successful, he hopes the transformation will also spread the wealth more evenly around the UK.

So there we have it, a Labour Government which intends to use fiscal policy to support the recovery and industrial activism to help rebalance the economy versus a Tory Party committed to slashing public spending and hoping that loose monetary policy alone will be enough. Robust recovery & rebalancing versus a possible double-dip recession and dependence on the financial sector.  Next week’s PBR will be interesting.

6 Responses

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  1. Tim Worstall said, on December 6, 2009 at 11:11 am

    “The solution must be found elsewhere: in a growth-oriented policy that encourages emergence of a more diversified economy. This should be done not by suppressing markets, but by supporting and guiding them.”

    Drop that “guiding” and you’ve got the Austrian description of what a recession is and how to get out of it. It’s a period of recalculation.

    Glad people are finally catching up….

  2. akabilk said, on December 6, 2009 at 7:53 pm

    I can sort of agree with the sentiment expressed both in this blog post and the supporting comment by Tim Worstall.

    However, I would say it must be based on the premise that the government has the capacity to maintain a deficit of the current size and/or raise sufficient funds from debt auctions to sustain borrowing.

    I may be mixing fund-raising means there but unfortunately I am no expert in these matters. I am however, a concerned citizen and as such I think I speak for many who might agree in some sense about what it being done but has limited confidence that those making these decisions are genuinely acting in our long term interests.

    So.. my question, can we afford these measures?

    Please don’t patronise by responding that we can’t afford not to.. I may only borrow money for which I have the means to repay and I don’t see it as being any different for a government.

    • Bill le Breton said, on December 7, 2009 at 12:36 pm

      Dear Akabilk
      What if you borrowed the money to go on a training course that prevented your present employer from down grading your present job by more than the cost of the course ?
      Or to buy a new tool for your company that kept it competitive with oversees manufacturers?
      What if you borrowed it from someone who knew you’d pay it back at a time when few others wanted to borrow it?
      B

      • Alan King said, on December 7, 2009 at 7:56 pm

        sounds reasonable, however I think we are still in the territory of supposing that the loan is available.

        If I can’t show a reasonable payback, no matter how laudable the ends, then I might not be able to convince the bank to make the loan.

        I guess the sentiment here is that if no-one actually stops the govt from borrowing at this time, then they should carry on until they can borrow no more.

        I am concerned what happens when the world markets say ‘no more’ or some (more) unexpected events put the current borrowing plans under greater stress

        Personally, I operate my finances away from the precipice of financial ruin, I think the govt owes us a duty to do the same.

  3. gastro george said, on December 7, 2009 at 5:17 pm

    Can somebody clarify?

    Are the bonuses usually based on a percentage of turnover or profit? As the talk always seems to be of the former (aka income). If so, and the banks can afford to give away such a high proportion of income, doesn’t that make the profit margin rather high? And if the profit margin is so high, then doesn’t that make it low risk?

    Or am I just showing my ignorance?

    • duncanseconomicblog said, on December 7, 2009 at 5:54 pm

      Gastro george,

      Generally salaries (and bonuses) are the biggest cost in investment banking.

      Profit margin on advisory work is huge.


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