by Adam S. Posen, Peterson Institute for International Economics
Op-ed in the Financial Times
February 22, 2013
© Financial Times
The UK government's economic policies are too European. Not too pro-European, clearly. Nor too oriented towards Europe. They are too European in that they are inflicting on the British economy the same misguided approaches whereby European leaders have perpetuated the euro crisis. This week's fall in the value of sterling suggests those mistakes are having the same deleterious influence on growth and confidence in the United Kingdom as they had across the Channel.
The coalition is putting macroeconomic discipline ahead of structural reform. The guiding fantasy of euro area economic policy has been that if monetary and fiscal policy are tightened enough, people will have no choice but to stop behaving badly. This is the easy way out for politicians: instead of directly taking on special-interest groups and designing reforms, they can act tough and hope for the best. This approach has failed in Greece and is failing in Italy. It is also failing in the United Kingdom. Pursuing budget cuts with little reform of planning, taxes, or labor incentives, the government has diminished growth without any supply-side benefits to show for it.
Ministers are pursuing austerity too fast, with too little regard for investment. Even before the International Monetary Fund bravely told the inconvenient truth about fiscal multipliers, some of us warned that contracting budgets during a recession would be self-defeating. The United Kingdom, like other EU governments, is demonstrating this truth. It has in fact gone further by front-loading its austerity and aiming for the squeeze to come in the form of £4 of spending cuts for every £1 of tax rises. One cannot pursue that ratio without cutting deeply into muscle and bone: Public investment is down 25 percent in Britain, as it is in much of peripheral Europe.
Like the euro area, the United Kingdom is doing with monetary policy what should be done by fiscal policy. The unwillingness of northern European governments either to make fiscal transfers to the south or to write off the bad loans and recapitalize their banks has forced the European Central Bank to engage in many maneuvers that distort markets and hide bailouts. Similarly, the unwillingness of the UK government to put up money to deal with regional divergences and weakened banks has forced the Bank of England (BoE) to try schemes such as Funding for Lending, which simply perpetuate the damaged banking system.
The coalition is even favoring banks over borrowers. When loans that never should have been made go wrong, there is blame on both sides of the transaction: The borrower takes on debt he will not turn into productive investment and the lender pays for ignoring the warning signs. In northern Europe, banks have been spared the costs of their folly. They had the opportunity to shift their bad loans on to the ECB's balance sheet. While the United Kingdom did inflict losses on some bank shareholders, it has been European in its reluctance to write off the loans on the balance sheets of the banks it owns. Restructuring of consumer and small business debt overhangs has barely been tackled, hence new loans are scarce. The welcome Vickers Commission recommendations on bank reform remain to be seen in action—just like the new bank supervision in the euro area.
The split vote at the February Monetary Policy Committee (MPC) meeting, revealed this week, underscores the harm done by this approach. Sir Mervyn King, the BoE governor, and the two other members who voted (unsuccessfully) for even looser monetary policy, are concerned that delay in addressing the United Kingdom's economic problems is making them deeper. This is what I, Sir Mervyn, and others started warning in 2010 would occur if policy responses were insufficient. The MPC as a whole agreed, rightly, that "more targeted interventions to boost demand and the supply capacity of the economy, and to facilitate rebalancing, might be entertained, but many of these fell to other UK authorities." The government's macroeconomics is not promoting recovery.
Ministers also seem to suffer a fear of competition that is the hallmark of a stereotypically European approach. In the euro area, this has recently taken the form of reluctance to expose banks to competition from new entrants or foreigners. In the United Kingdom, however, this fear has produced the most concentrated banking system in any major economy. Calls to break up, sell, or change the shape of the publicly owned banks have come to nothing. There has been little encouragement of new competitors. The United Kingdom has gone backwards on skilled immigration, limiting entry in a way that past British leaders ridiculed certain plumber-phobic neighbors for doing.
Britain has, however, created new institutions. We now have the Office for Budget Responsibility; the BoE is set to become a multitasking behemoth, precisely because it and other central banks failed to supervise commercial banks. This is truly European: When you have a problem, define it as a lack of an institution, not a lack of will or resources. But institutions have to do something to be useful—shifting responsibilities is no substitute for actual policymaking.
Worst of all, the UK government is following the euro area model of leaving hugely important decisions hanging. Such failings are perhaps unavoidable when negotiating among 17 euro area members and 27 EU countries. The Greek bailout and the ECB commitment to prevent sovereign bond panics in the euro area took two years. David Cameron's government has rightly criticized its European partners for this dawdling. Yet the coalition now says it will take months to review the terms of the BoE's inflation-targeting regime and will allow years to pass before holding a referendum on Britain's EU membership—creating a cloud of uncertainty over investments in Britain.
It is time for the UK government to take a good look in the mirror and see that its policies are now following the very European patterns it mocks. It is not merely somewhat embarrassing. These policies are in large part to blame for Britain's failure to recover from the financial crisis.
Testimony: European Banking Union: Current Outlook and Short-Term Choices February 26, 2014
Policy Brief 13-17: A Realistic Bridge Towards European Banking Union June 2013
Op-ed: Five Myths about the Euro Crisis September 7, 2012
Article: Why the Euro Will Survive: Completing the Continent's Half-Built House August 22, 2012
Testimony: Challenges of Europe's Fourfold Union August 1, 2012
Policy Brief 12-18: The Coming Resolution of the European Crisis: An Update June 2012
Book: Resolving the European Debt Crisis March 2012
Policy Brief 12-20: Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups August 2012
Policy Brief 12-5: Interest Rate Shock and Sustainability of Italy's Sovereign Debt February 2012
Speech: Italy's Effect on the Global Economy February 9, 2012
Policy Brief 12-4: The European Crisis Deepens January 2012
Policy Brief 11-13: Europe on the Brink July 2011
Working Paper 11-2: Too Big to Fail: The Transatlantic Debate January 2011
Policy Brief 10-27: How Europe Can Muddle Through Its Crisis December 2010
Policy Brief 10-14: In Defense of Europe's Grand Bargain June 2010
Op-ed: The Follies of Federalism August 5, 2007
Book: Transforming the European Economy September 2004