We can't spend our way out of economic crisis. But we can cut taxes
George Osborne will stand up to deliver his budget speech this week to a chorus of calls for a "Plan B". With the UK struggling to grow, Europe continuing to flounder and the US in a relative sweet spot, intellectual consensus has swung sharply against austerity. But to paint the picture as a straight choice between austerity and growth is intellectually dishonest. The reality is that whatever plan is implemented to resolve the debt crisis, the effects will be painful.
Simplistically pointing to the outperformance of the US economy as evidence that there is only one correct policy path is the wrong approach. We do not yet know how the Federal Reserve's policy will turn out – it might have a worse crisis in future as a result of current actions. US debt stands at almost $17 trillion, more than $50,000 (£33,000) for every person in America. It is far too early to declare that the Fed is on the right path – it is simply following the strategy of governments of all political persuasions during the financial crisis and delaying the repayments. In a democratic system it is too tempting to use a future government's budget to buy favours now. Tomorrow is another day but it is also someone else's problem.
Growth is an outcome, not a policy. The question is: how do we get there? Politicians would have us believe they have all the answers, but the truth is that there is no way out of the debt problem without someone picking up the tab. We can move debt from private-sector balance sheets to public, place the burden on savers rather than borrowers, start taxing wealth rather than income. But these are simply choices about allocation of the costs, not magic wands of wealth creation.
Much research has been done on the problems of excessive debt for economies. Once the sovereign debt burden becomes too great (the tipping point appears to be around 90% of GDP), any attempt to service or reduce it becomes self-defeating. Currently, the UK's debt is 85% of GDP (although you can get to a lower figure depending on what debts you exclude). Cutting government spending or raising taxes to lower the deficit hurts growth (which increases the deficit). The recent poor performance of the UK economy has been seized upon by certain commentators as proof that an austerity-led approach is wrong. But that argument also implies that the "spend and print" path is correct.
If wealth could be created by printing money, Zimbabwe would be the richest country in the world and schoolchildren would be learning about the Weimar economic miracle. The fact that "spend and print" seems so favoured by politicians suggests that they do not understand the cost of quantitative easing.
In the 1970s £100,000 would buy you a mansion; now it might buy you a London parking space. That is ultimately how proponents of QE hope to solve the debt burden. But QE doesn't just attack debt; it also attacks the purchasing power of money. The debt is still being repaid; it is just being repaid in the form of accepting a lower standard of living for all. Instead of the government taking an extra 5p in the pound from your wages, it is making £1 of goods cost £1.05.
What is the difference? A pound of direct taxation can be raised in any number of ways, through income, from corporate profits, mansion taxes – whatever takes the fancy of the government of the day. A pound of QE's indirect taxation manifests itself in the cost of goods, and that burden falls hardest on the people for whom these costs are the highest share of their disposable income, namely those with the lowest incomes.
When people talk about inflating away the debt, they mean that savers should pay back the debt instead of borrowers. When people push for more QE, they are arguing for all members of society to pay back the debt incurred by a few. When Keynesians claim that deficit spending is imperative, they mean that current taxpayers should be supported at the expense of the future ones. This debate is about allocating the costs, not generating the wealth.
There are no simple ways to create growth. Governments simply spending more money won't necessarily solve it. We could build a winding staircase made of gold a mile high and it would add to GDP, but it would still be non-productive. Spending the same money on an engineering college for students who do not want to incur tuition fees would be far more beneficial – but its effects would be slow to materialise. Politicians like to blur the line between spending and investment, but only one can ultimately help growth.
But fiscal stimulus does not solely mean the government directly spending more money; it can also mean cutting taxes. Osborne could raise the tax-free allowance to £15,000 to help those who are most negatively affected by QE; give tax breaks to companies that build factories here to take advantage of our weakening currency; and remove employers' national insurance contributions so that it is more attractive to hire workers.
All those tax cuts should help stimulate growth. We tried spending our way to growth and blew up the economy. We have tried austerity but cannot get public spending to fall. Maybe it is time to try tax cuts.
Dr Guy Wolf is global head of market analytics at Marex Spectron, a broker to the commodities sector.