In my Money Week column thios week, I've been writing about why Ed Balls will be a disaster as Shadow Chancellor. Here's a taster....
Almost alone among an anodyne generation of British politicians, Ed Balls has the ability to divide opinion. When the Labour Leader Ed Milliband appointed him as Shadow Chancellor last week plenty of people saw him as too addicted to back-stabbing and briefing to ever make an effective team player. But most praised his economic expertise, and concluded his combative approach would make life a lot harder for the Conservative-Liberal Democrat coalition.
In fact, that consensus is upside-down. Balls’s aggression, and his ability to make the life hard for his rivals, are his strengths. His weakness is his shaky grasp of economics. He’s got just about every major call on the economy wrong. And he has made himself the leading exponent of a crass version of Keynesianism that is going to end making him look absurd.
By constantly making the wrong predictions, and attacking the government for quite sensibly policies, Balls will ruin his party’s credibility. He will make the re-election of the coalition in 2015 far easier.
As it happens, Balls’s record provides plenty of ammunition for his opponents. He was the key economic adviser to Gordon Brown during his ten years as Chancellor. He boastfully claims authorship for many of his former boss’s policies, even though most of them later turned out to be catastrophic. It isn’t going to be hard to pin his past on him.
The new system of financial regulation put in place after 1997 led to the worst string of bank collapses for more than a century. The decision to run-up a vast budget deficit even while the economy was booming looks to have been a costly mistake. The housing market was allowed to run riot, mortgage lending spiralled out of control, and the trade deficit reach new heights. It wasn’t much of an economic record.
Balls points to the independence of the Bank of England and keeping Britain out of the euro as achievements. But, at the very least, these are questionable. The Bank has not done a great job of managing the UK economy. First it gave us the housing boom, now it is giving us rampant inflation. What’s so great about that? As for the euro, the Labour government could never have signed up to it without a referendum, which would have been decisively lost, so that was hardly a personal victory for Balls. It’s like claiming credit for stopping an invasion by Martians. Since it was never going to happen, it’s not much of a deal.
But electorates aren’t much interested in history.
Right now, and for the next five years, Balls is relentlessly pushing the line that the cuts are too fast, and will push the economy back into recession. Much of the media has fallen for this line as well. If you listen to the news, you’ll constantly hear that reducing the deficit may derail the recovery.
It is, however, complete nonsense.
The latest economic research suggests that, contrary to what we kept being told, deficit reduction leads to faster economic growth. And the governments that cut spending tended to be rewarded with re-election.
Take a look at the work of Harvard’s Alberto Alesina, for example. “The conventional wisdom about the political economy of fiscal adjustments goes more or less as follows,” he wrote in a paper for Ecofin last year. “Deficit reduction policies cause recessions which create political problems for incumbent governments. The latter therefore see fiscal adjustments as the kiss of death.” That’s very much how Balls sees it. The cuts will cause a recession, and a backlash against the coalition. “Fortunately the accumulated evidence paints a different picture,” continues Alesina. “First of all, not all fiscal adjustments cause recessions. Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run….Second and this is most likely a consequence of the first point, it is far from automatic that governments which have reduced deficits have been routinely not reappointed.”
Indeed so. In fact, cutting the deficit doesn’t lead to a recession. It more often leads to a period of rapid growth. That was true in this country in the early to mid-1990s, when big cuts in spending led to sustained recovery. It was true of Sweden and Canada in the 1990s as well. Alesina’s study looks at 107 examples of fiscal consolidation, defined as cutting the deficit by 1.5% of GDP or more, within OECD countries since 1980 and found that in nearly all cases it was followed by higher growth rather than lower.
There’s no great mystery about why that is. Of course, cutting spending takes demand out of one part of the economy. But it puts it back in somewhere else, either because the government taxes less or borrows less. There’s no reason why the overall level of demand in the economy should change.
Cutting the deficit, however, helps the economy in other ways. It improves confidence, as consumers and businesses worry less about future tax rises. Real interest rates may fall as the markets grow more confident about government finances, and that stimulates investment. The stock market usually rises, increasing demand as people’s wealth rises. And, of course, since a smaller state and lower taxes are usually good for the economy, anything that makes government smaller rather than larger will help promote growth. Indeed, another key finding of the research is that not only does deficit reduction help growth. The more spending cuts are used to cut debt rather than tax rises, the higher the rate of growth that follows it will be.
The evidence is clear. Cutting the deficit makes an economy grow faster not slower. That is true of just about every other country in the last thirty years. There is no reason why it shouldn’t be true of the UK over the next four years as well.
But Balls doesn’t get it. He insists the opposite is true. A Shadow Chancellor who spends five years issuing blood-curdling warnings about the economy, none of which come true, is not going to impress the electorate very much. He’s just going make himself and his party look stupid.