November 19, 2008 | posted by Michael Baxter in UK economy |

Imagine you feel rotten. Confined to bed, a friend pops around with this medicine. It is magnificent at dealing with the symptoms. Your temperature falls to normal, you feel as right as rain. You are not better of course, far from it, but you feel better. Then you do something stupid, you go skinny dipping in the middle of winter, or something. You know what will happen next. When the medicine masking your symptoms wears off, you will feel worse, a lot worse.

So what has that got to with the business and the economy? Answer: maybe quite a lot. It depends.

At last, daylight has appeared, real daylight, between the economic policies of the Tories and Labour. It’s a tag team contest, really. On one hand you have Brown and Darling, let’s call them the Red Devils. They have a secret weapon – Keynesian economics, and the policy of spend, spend. On the other side of the ring, you have the Blues Brothers. Cameron and Osborne – fresh-faced, but secretly wielding a sword called prudence.

Are you ready to rumble? Who is right?

It all depends on what you believe caused the economic crisis of 2008.

If you believe it is down to bankers, mortgage securitization, and the great US subprime error, then it seems the UK’s economic malaise is down to bad luck. The UK, it seems, has been struck by a perfect storm of misfortune. But there is a real danger that the damage caused by this storm will be long lasting. The recession could deepen and then a downward spiral could result. If people save more, because they are scared, businesses will find demand is inadequate for them to meet their overheads, businesses will go bust. Banks who have lent to these businesses will suffer more bad debts, so, in anticipation of this event, they cut back lending in advance. Individuals who have become used to living off their overdraft, and then lose their jobs, will find they can’t even afford to pay the charges on their overdraft. In anticipation of this, banks will reduce overdrafts, creating problems for individuals, even when they have a job, forcing them to cut back, forcing aggregate demand across the economy to fall.

In such circumstances there is only one thing for it. Spend before the downward spiral develops. Fund the banks so they can afford to carry on lending, give tax back to those who are most likely to spend it, and invest in large infrastructure projects which will result in the employment of people who have lost jobs in the construction sector.

Above all, get spending and borrowing back to 2007 levels.

If you believe the above analysis is right, then the Red Devils have hit the nail on the head. They will go down in history as the most successful tag team in peacetime politics.

But, there is another way of looking at it.

If you believe the fundamental problem is that savings have been too low for years, that consumer debt had been allowed to rise too high, that surging house prices gave an illusion of prosperity, which in turn encouraged an unsustainable boom, then it is possible the Red Devil approach will make things worse.

David Cameron likens it to taking out a new credit card, to pay off the debt on another card.

If that analysis is right, then a Keynesian boost will merely mask the symptoms.

There is one snag, though, with this plan hatched by the Blues Brothers. Where were their warnings 18 months ago? There were plenty of articles in the press, including here, warning that debt had risen too high, that house prices were too high, and that a nasty crash was inevitable, but Cameron and Osborne were silent.

Brown and Darling, however, are, if nothing else, consistent. They said the economy was in good shape, they said the UK was in a better position to withstand a recession than most other economies, and if that analysis is right, then so is their plan.

David Cameron’s plan represents a complete turn around in policy, analogous to the errors made by John McCain in September, which is when most political commentators say he lost the US election.

This, however, disguises an even deeper problem.

We like our political leaders to be consistent, firm, strong. If a political leader admits they made a mistake, then more often than not it’s curtains on their career. The reality should be different. All politicians get it wrong. No one predicted the severity of this economic crisis. We live in an uncertain world – and the people who are best adapted to lead are the ones who are willing to change. This is precisely the approach that is doomed to create electoral failure.

The fundamental truth is this: consumer spending reached a level in the UK which was just unaffordable. The economy has adapted so that it relies on this unsustainable level of spending. The economy has to be re-aligned. This can only be painful. A Keynesian boost will be good for the economy, but only if the money is spent in the right areas.

If the UK comes out of this recession with a new, improved transport infrastructure, and with massive renewable energy capacity, then we will be better off as a result.

Recessions are important. A farmer understands that winter is essential. It gives the land a chance to rest, and crops then re-grow with new vigour in the spring. Over-farming leads to desertification. If money is used to maintain the old way of doing things, then the UK will be weaker as a result.