Duncan’s Economic Blog

The Real Big Issue: Government Spending or the Wage Squeeze?

Posted in Uncategorized by duncanseconomicblog on June 8, 2011

I’ve been inspired to break my ‘no blogging when on holiday’ rule by a few reports this week.

We got the IMF’s latest update on the economy, the downgrade in growth forecasts was no surprise – the IMF was simply out of line with the OECD and other forecasters. The UK is now in a downgrade cycle, one can reasonably expect the OBR to downgrade it’s own forecast when it’s next updated (which I assume is in November at the next economic and fiscal outlook) and I doubt we have seen the last downgrade from the Bank of England.

These downgrades make for grim reading for the Treasury and will make the task of reducing the deficit that much harder.

But they don’t necessarily spell good news for Labour.

The IMF, the ratings agencies and (despite recent wobbles) the OECD remain backers of George Osborne’s approach. We can disagree with them, we can point of the potential pitfalls of there approach and we can worry that the strategy may prove self-defeating but we can’t close our eye to this.

Those (like myself) that argue against the speed and depth of Osborne’s austerity agenda (too far, too fast)  can marshal Nobel Prize winners, current and former members of the Member Policy Committee and  various other prominent economists on our side. But so can George Osborne.

One sometimes gets the impression reading left wing blogs that George Osborne is a complete economic illiterate and out of touch with all sensible opinion. This isn’t exactly true.

As I’ve tried to point out the real debate here, as in so much of macroeconomic policy, is around a balance of risks – in this case the risk of a bond market panic driving up the cost of borrowing (which I perceive as less likely than HMT) versus the risk of tough austerity damaging the economy (which I perceive as more likely).

What I occasionally worry about is that elements of the left perceive government spending as the only answer.

I’ll be very clear – cutting government spending at a rapid pace whilst demand is weak risks serious damage to the recovery. But it is unclear to me (despite good work by, for example, Anne Pettifor) that more government spending is necessarily the answer.

Labour oversaw a relatively large expansion in state spending in the second half of it’s time in office (although without increasing tax revenues by a corresponding amount). Whilst many of the outcomes of this were beneficial (vastly improved health and education services, a marked fall in child poverty), outcomes that we should be proud of and strive to repeat,  the overall macroeconomic impact is debateable.

The question that people in Labour should be asking themselves is this – do we just want to go back to 2006? Before Northern Rock, before Lehman’s and when Labour had a reputation for economic competence. Back in 2006 it was business-as-usual for Brown at the Treasury, a steady increase in state spending increasingly financed not by taxes on ‘voters’ but by bubble-related revenues from frothy asset markets and a credit boom.

As important work by CRESC has shown
, the UK’s ‘undisclosed business model’ was reliant on a combination of finance in the South East (including London) and then para-state in the regions. The actual productive and real private sector was anaemic.

This model may have succeed in generating a decent rate of GDP growth but is failed many ordinary people.

As recent and highly relevant work from the TUC and the Resolution Foundation has shown. The TUC note that:

The wages of middle income Britain have grown by an average of just 56% since 1978, despite GDP increasing by 108% over the same period. For workers in some skilled trades incomes actually fell in real terms between 1978 and 2008.

The Resolution Foundation’s recent work has demonstrated that between 2003 and 2008 median wages flat-lined and disposable income actually fell in every English region outside London despite headline economic growth of 11%.

I remain convinced that ‘wage-led growth’ is the not only the best route out of the current crisis but also offers a more sustainable future and a model of growth that will benefit ordinary people. Osborne’s policies in this area are totally wrong, he is adding to rather than alleviating the squeeze in living standards. His economic projections are underpinned by a rising level of household indebtedness. He seems to agree with Mervyn King that this is all somehow inevitable.

I’d rather we on the left spent more time focussed on this and less arguing about the right level of government spending.