Dangers of slashing public spending
In March we ran a lengthy extract of an interview with financier Jim Rogers, who described the perceived G20 wisdom on running huge deficits to boost world growth as “ludicrous and insane”. It is one of our most downloaded videos of the year.
Today, the perceived wisdom turns to The Great Retrenchment, as Gordon Brown outlines his Smarter Government spending cuts to compete with those outlined by the opposition. So today I offer you a similar though opposite corrective to the current perceived wisdom: Richard Koo, who thinks Britain is about to make the same mistake as Japan did just over a decade ago.
Koo is the foremost analyser of Japan’s lost decade of growth, as the chief economist of Nomura Research Institute. He’s presented at the Treasury, went to the Bank of England, and had a coffee with George Osborne.
If he’s to be believed, Britain’s political classes are leading us, lemming-like, into a catastrophic decision to prematurely slash public spending and raise taxes.
“That’s exactly the mistake we made, because when we saw the economy recovering – in 1996 we had 4.4 per cent growth, the highest amongst G7 countries – we said ‘wow the economy’s recovering, we don’t need a fiscal policy anymore’, so we cut it and we had five quarters of negative growth, a banking crisis that triggered the Asian currency crisis,” he says.
So when today we hear from the government of its plans to make £12bn of efficiency savings, or in the PBR of an effective £40bn cut in spending it’s worth remembering this Koo-ism. At a similar stage in its economic cycle, the Japanese government made great play of cutting 15 trillion yen from its budget deficit through spending cuts and tax rises. The policies led to a 16 trillion yen INCREASE in the deficit.
Deficit reduction should not be the first priority in a so-called balance sheet recession he says. In essence, he is arguing that unless you are sure that the private sector has stopped the process of conservatively saving and paying down debt, so-called deleveraging, then you should continue to expect the government to step in.
“If you try to do a fiscal reform prematurely, I can assure you your budget deficit will increase not decrease. The Japanese budget deficit increased by 30 trillion and it could happen here too. We have to check whether the private sector is borrowing and spending money again as before then, cutting the fiscal deficit will be an horrendous mistake.”
As the UK suffers a budget deficit of 12 per cent of GDP, only previously reached during world wars, this might seem a little pie in the sky. And the Treasury might well be more concerned by what economists at Standard & Poor’s and Fitch think about UK sovereign creditworthiness rather than Mr Koo’s views on the recession. But he thinks that the UK should not just ignore the credit ratings agencies, but actively “go after them”.
‘These rating agencies downgraded us [Japan] to a level below that of Botswana in Africa because they thought that with that kind of debt growth – at some point interest rates would go sky high and the whole sky would come crashing down. They were never proven correct, bond yields in Japan kept on falling, and stayed the lowest in human history for the last ten years. Why were they so wrong? Why will they not be held accountable?’ he says.
Of course Japan has a giant pile of domestic saving from which to fund its huge government debts, which is not currently the case with the UK, but it does get you thinking the unthinkable. Much is made of the merest meander in the minds of economists at ratings agencies. Yet their kind was one of the main causes of the actual credit crunch.
On bonuses, as I tweeted last night, what is being cooked up is not, even slightly, a windfall tax. The most interesting aspect of this purely political policy is to see at what point the Tory frontbench crack, and start defending bankers from their bashing by Mr Brown.