Eurozone Crisis

My Lords, I find myself agreeing very much with the speeches of the noble Lords, Lord Lamont and Lord Lawson, but that is because they talked about Europe and not about Britain. I have always been a strong supporter of the European Union, but Britain was right to stay out of the euro. The eurozone has always been a flawed construction, created for political reasons. It never had the political and economic institutions needed to make it work. Gordon Brown should be given credit for keeping Britain out. We had more tools to deal with the crisis: fiscal policy, control over our exchange rate and a central bank which can buy gilts almost without limit. I agree with those noble Lords who have argued that the eurozone should, and probably will, break up, either into a northern and a southern tier, or in a more disorderly way. But the eurozone crisis should not be used as an excuse for the failures of domestic policy. Of course, it is true that it has worsened the prospects of a swift British recovery, but in fact stagnation in our economy had set in before the European crisis exploded. At any rate, growth started to slow down in Britain almost from the moment the Chancellor announced his confidence-boosting programme of budget cuts in June 2010. It went from 1.1 per cent in the second quarter, to 0.7 per cent in the third quarter, to minus 0.5 per cent in the fourth quarter. According to the OBR the British economy will grow about 0.9 per cent this year; it is expected to grow 0.7 per cent next year, and then to pick up to 2.1 per cent in 2013, with a one in three chance of recession next year. Miserable though these figures are for the third and fourth years of a supposed recovery, I believe they are overestimates. Our growth figures are having to be revised downwards. For example, in mid-2010 both the IMF and the OECD forecast a British growth rate of 2.5 per cent in 2011, 2.9 per cent in 2012, and 2.8 per cent in 2013. As I have said, we will be fortunate to reach 1 per cent this year. It is hard not to be sceptical of these forecasting models. A lot of them are pure bamboozlement and depend upon assumptions which are plucked out of the air. There are two systemic mistakes being made. First, I believe they underestimated the positive effects of the monetary and fiscal stimulus in 2009-10 in helping recovery. Secondly, today they underestimate the effects of the fiscal contraction in retarding it. The direct effect of the government cuts is to take spending power out of the economy when spending power is exactly what a depressed economy needs. The continual shrinkage of demand increases the debt and devalues the assets of both banks and Governments. It is thus a direct cause of the financial crisis today, as indeed it was—I am talking here as an economic historian—in 1931, when the financial crisis spread from central Europe to London. The banking system is certain to crack if the economy contracts. That is why it is far more important to plug the hole in the economy than to plug the hole in the Budget. The Chancellor is at last showing signs of recognising this. As the noble Lord, Lord Monks, said, this is not just a crisis in the economy but a crisis in economics. One of the problems of our arguments is the lack of any fundamental economic theory, particularly on the Government’s side of the debate. Macroeconomics, as a discipline, has virtually collapsed. Finance theory is hardly taught in the universities. So what we have is a kind of primitive microeconomics backed by Victorian aphorisms—you must not get into debt, or, if you do, you must pay it off as quickly as possible, and therefore you must reduce your spending, increase your savings and tighten your belt. I do not decry any of that. I do not condone either the extravagance, greed and myopia that led to the crashes of 2007-08. However, I think that Adam Smith was wrong when he said: "““What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom””." He ignored the fallacy of composition; it is as simple as that. I think that we are in danger of forgetting that one person’s spending is another person’s income. We must always remember that a Government have control over their spending but not over their income, as I am sure both noble ex-Chancellors will agree. If, by spending less, a Government cause the economy to fail, their own income or revenue collapses and they therefore will not be able to meet their targets. Already, the Government are having to borrow £111 billion more than they anticipated over the next five years; in my view, that is a direct consequence of the policy of cutting. Critics of the Government's policy always face two charges. The first was voiced today by the noble Lord, Lord Lamont. He pooh-poohed the stimulus advocates by saying that their argument amounted to saying that if we borrow more money today, we will have to borrow less tomorrow. The implication was that this was a ridiculous remark: you reduce your borrowing by borrowing more. Nevertheless, the fact is that we are having to borrow more today as a result of trying to borrow less, because the economy is not growing. That is what missing your targets means. What matters is the level of output and employment in the economy and its growth. If you take actions to restore the growth, the deficit will automatically fall away—not completely by any means but certainly partially. Secondly, the Chancellor claimed that the Government’s deficit reduction plan has saved the taxpayer £21 billion by keeping the cost of government borrowing down. It is true that UK gilt yields, currently at 2.4 per cent, are among the lowest in Europe, even briefly dropping below German bonds. However, the savings pencilled in by the Government—that £21 billion figure—depend on sustained economic recovery. If the cuts continue, what little economic growth is predicted will surely disappear. As it did this Tuesday, the OBR will revise its borrowing figures upwards again, and the growing size of the deficit will negate any savings made on the rate at which the Government borrow. Nor do I think that it is the deficit reduction programme that has kept the cost of government borrowing down. The fall in UK interest rates is entirely due to the danger of sovereign debt default by European countries; and the bond markets and pension funds know that the UK will not default. Of course you can say that they know that it will not default because of the Budget reduction policy. It is not that at all. We have tools, including the ability of the central bank to purchase gilts, which means that the danger of default has always been negligible. I know that there are huge complications in applying Keynesian wisdom today, as the noble Lord, Lord Desai, pointed out. But we must start from some point of economic theory or we will simply be battered by day-to-day events. If we do not have some basic theory behind us, we are intellectually and morally adrift. I use the word ““moral”” because the choices made by the Chancellor are morally deplorable. They are consigning to the scrapheap millions of people who are able and willing to work. By destroying their spirit and their skills, he is creating the very bleakness to which we are now being asked to adapt ourselves. Policy should aim to build up, not cut down. The economy does not require the arts of bleeding, but an injection of vitamins.