Tuesday, May 05, 2009

Cycling To Disaster


You've got your economy cycling around your trend growth rate - now, what could be easier?


Do you remember all that bunkum Brown and Balls cooked up about balancing the budget over an economic cycle?

They never did it of course. But they did expend huge amounts of Treasury effort and credibility fiddling the numbers to pretend they had. And the specific numbers they fiddled were the adjustments made to their budget deficits supposedly to correct for the phase of the economic cycle.

No, please - don't switch off. Economic cycles can be deeply entertaining. Not least because they wiggle around a lot, and take on all manner of hilarious chameleon hues depending on who's looking for them.

Robert Chote of the Institute for Fiscal Studies, who has long been critical of the Brown/Balls version of recent cycles, has just published an excellent article spelling out the full extent of their fiddling (and see this commentary). He begins:

"If the picture painted by the Treasury in this year's Budget is correct, we are currently suffering a "bust" without having enjoyed a "boom". The official story is that after the dramatic ups and downs of the late 1980s and early 1990s, the current government kept activity in the economy impressively close to its "Goldilocks" level - neither too hot nor too cold - until a virulent strain of banking flu arrived unpredictably from the US and pushed us into recession, as well as sharply reducing the economy's long-term productive potential."


Here's his handy picture of this fantasy world:

As we can see, in the Brown/Balls world, everything is ticking along nicely, nicely, nicely... right up to the moment when it isn't. At which point, suddenly and out of the blue, output collapses by a staggering 10%, half of which we've apparently lost for ever.

Chote goes on to highlight that Brown's entire Goldilocks confection rested on the whacky assumption that our trend growth rate had miraculously cranked up from its post-WW2 average of under 2½% pa, to almost 3½% pa in Labour's first term, and then sticking at 2¾% a year thereafter.

If instead you assume something closer to our 2½% pa long-term average trend growth, then - hey presto - most of Brown's miraculous nomoreboomandbust growth decade becomes mere cyclical overheating, no different to what many failed Chancellors have delivered in the past (think Maudling, Callaghan, and Barber):

In truth, the very term "cycle" is misleading. Cycle suggests regularity and predictability straight out of a GCSE physics textbook (which is pretty well where it originated). But the messy reality is very different.

In theory, the cycle provides a simple rule by which governments can manage their fiscal affairs. When the economy is enjoying a "cyclical boom", tax revenues are high, social security spending is low, and governments shouldn't need to borrow much; indeed, they need to be repaying existing debt. Conversely, when the economy is suffering "cyclical weakness", tax revenues fall, social security spending rises, and the government should borrow to "tide the economy over".

So in theory, a really prudent government could establish a... oooohh... what should we call it?... a Golden Rule. And under the Rule, it would only borrow to tide the economy over a period of cyclical weakness, ensuring that any borrowing was temporary and balanced by repayment during periods of cyclical strength. Easy.

But in the real world, the cycle is not like a GCSE science textbook. In fact, it's not science at all, but art - and as we know, art is anything the artist says it is. Moreover, this particular art is invisible to the human eye, and there's not even an agreed description of how it should look.

In the real world, all you actually have is a time series of GDP figures. There is no big red warning triangle popping up to say "this is a period of temporary cyclical boom, so you'd better stop borrowing and repay some debt". You have to judge whether the economy is temporarily above or below its trend growth rate, which is itself invisible and unknown.

So now you're the government. A government wedded to high public spending. What do you do?

Why yes, that's right. You strain every statistical sinew to downplay the unsustainable cyclical component of GDP, and exaggerate the sustainable trend component. Because that way you get to spend all those lovely bouyant tax revenues, rather than having to save some of them for a rainy day.

Of course, eventually the cyclical boom ends and the money runs out. But by then, you're either already out of office, or pretty soon will be. It's someone else's problem.

On the basis of Chote's two charts, we can see how Brown systematically overestimated the sustainable trend component of GDP and underestimated the temporary cyclical component. The error/fiddle was of the order of 4% of GDP.

Therefore, based on HM Treasury's normal rule of thumb - that every 1% on GDP reduces government borrowing by 0.7% of GDP - Tyler's fag packet says that Brown overborrowed by 2-3% of GDP for most of his reign. Cumulatively over a decade, that amounts to something like 25% of GDP, or around £350bn - a colossal amount even by his own outrageously reckless standards.

So what does this tell us for the future?

First, although it's tough, somebody does need to make a judgement on how economic conditions are impacting on borrowing: nobody is saying the government should attempt to balance its books in the teeth of an outright recession.

Second, that judgement should never again be left to the government, nor any of their supine placemen, such as HM Treasury. We desperately need George's independent fiscal monitoring authority, modelled on the National Audit Office and reporting to Parliament (for want of anything better).

It must of course be headed by someone of proven integrity who's also well versed in the public finances - an admittedly unusual combination. Modesty naturally forbids, etc, but Tyler can think of one or two other candidates - what about Chote himself? He'll need a solid Chairman, preferably one of our few remaining seagreen old-skool mandarins such as Sir Michael Scholar.

And both backed by a board comprising prickly small government zealots (Tyler can supply a rapidly lengthening list).

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