The UK government’s Chancellor of the Exchequer, George Osborne, has today announced that his prized goal to achieve a budget surplus by 2020 will be abandoned, as reported by the BBC here. This is apparently justified by the likely shock to the economy resulting from the outcome of the recent vote to leave the EU.
Before the anti-austerity camp throw up their hands in celebration, this apparent sign of flexibility may simply mean that, in the absence of a change of government, tax rises and spending cuts may go on for longer. But flexibility is to be welcomed, especially if the economy slows significantly, which could lead to a relatively larger budget deficit than otherwise.
I have argued before on this blog, and the government has paid lip-service to the fact, that a major rebalancing of the UK economy is required, away from debt-fuelled consumption, and towards investment and exports. This rebalancing would help reduce both public and private borrowing, while sustaining growth and employment. The recent fall in the pound may help this process, although this is by no means certain. If exports and imports do not respond sufficiently to the change in the exchange rate, then the current account deficit may not be reduced. It is the latter which reflects the UK’s imbalance between savings and investment at the international level, and a corresponding imbalance domestically.
Osborne’s target for achieving a budget surplus was always highly suspect, as the economics of it paid insufficient attention to its relationship to the evolution of private sector debt, at both the domestic and international levels.
It takes some simple macroeconomic analysis to show that, although a strong exchange rate may reflect confidence in a nation’s economy, if it leads to a large current account deficit and the continued accumulation of debt by the private and public sectors at a rate greater than the expansion in GDP over time, then this will at some point prove to be unsustainable.
The proponents of austerity, Osborne included, have waxed lyrical on the need to reduce the deficit and the national debt to sustainable levels. This is hard to disagree with, but as already mentioned, the evolution of public borrowing cannot be considered in isolation. If the current account deficit were to fall from its current 7% of GDP towards the rate of growth of the latter, which could be perhaps 2%, then the accumulation of debt relative to GDP would stop. As long as this adjustment is not at the expense of GDP growth, then the resulting rise in savings relative to investment would by definition help to rebalance the domestic economy. Both private and public debt relative to GDP would also stabilize, and Osborne’s goal could be achieved. Austerity on its own will not achieve this, while sustaining growth, unless the large imbalance between UK savings and investment, both domestically and internationally, is resolved.
Having said all that, the requisite rebalancing, while growth is sustained, will also require adjustments in the opposite direction by those among the UK’s trading partners who are running current account surpluses with us. A surplus on the current account represents an excess of savings over investment. This can be seen in Germany, which has been running a large surplus for some time. If Germany and other surplus economies do not adjust, then the UK will not be able to either. After all, one country’s current account surplus is another’s deficit, and the too must balance globally. A large change in the exchange rate between the pound and the euro may help, but however the rebalancing happens, it is fundamental to sustained growth both in the UK and the Eurozone.
Imbalances between savings and investment, reflected in current account surpluses and deficits, giving rise to patterns of weak domestic demand in economies such as Germany, and debt-fuelled consumption and asset price bubbles in economies such as Spain, were at the core of the Eurozone crisis and the region’s subsequent stagnation. If they are not resolved, political instability and rising support for nationalist and extremist groups will continue across the continent. If this continues, the breakup of the Eurozone cannot be ruled out.
In the case of the UK, it may be seen as welcome that the government shows some flexibility over its austerity agenda. Indeed, Osborne has already shown a willingness to continually adjust his borrowing targets as economic circumstances have altered. But the obsession with reducing the budget deficit to the neglect of other measures of the state of the economy and its growth potential is proving remarkably short-sighted. A major rebalancing may not only require further falls in the pound, but also more public and private investment in ways that improve the growth rate of productivity, as part of a coherent industrial and technology policy. This should aim to promote the growth of net exports. A significant recovery in domestic demand in the Eurozone’s surplus economies is also required, although this is largely out of the hands of the UK government.
Without such changes in economic policy and performance in the UK and across Europe, the prospects for sustaining a liberalism which supports the prosperity of the widest possible demographic in these regions of the world, and more widely, look bleak.