Response from Gavyn Davies OBE

Responses to Osborne’s Choice Related publications
Osborne’s Choice: Combining fiscal credibility and growth

The political debate on fiscal policy in the UK has become increasingly polarised. The government and opposition both accept that there is a need to reduce the budget deficit, but the speed at which this should be done represents a key polemical difference between the parties. Whether the difference is really as great as the polemics make it seem is another matter.
George Osborne’s rhetoric supports a more rapid fiscal tightening than Ed Balls’, though it is noticeable that the Chancellor did not actually implement that tightening last year in the face of slowing GDP growth. Instead, he simply accepted the over-run in the budget deficit in the near term, and vaguely promised further unspecified public spending cuts after 2015. He is not quite as inflexible on the fiscal path as he is often painted.
Meanwhile, the Shadow Chancellor calls for a cut in VAT, but this does not seem sufficient to place the economy on a radically different path from the one which is emerging from the government’s strategy. Although Mr Balls’ repeated warnings about the results of austerity in the 1930s suggest that he favours a much more full-blooded Keynesian response to the crisis, he knows that this is not something which the public would accept at present. At least for now, the Tories have won the political debate on borrowing, even if the substantive debate in the economics profession is far from over.
Should fiscal policy be eased in the immediate future? Certainly, it would result in stronger GDP growth for a while, and Mr Osborne would be wrong to deny this. The Chancellor is right, however, to suggest that it would also involve a greater chance of a fiscal crisis which could ultimately prove very difficult to reverse. Just because the fiscal crisis has not happened yet, this does not mean that it will not ever happen. But the trade-offs between immediate GDP gains versus increased, and hard-to-measure, “tail” risks of a crisis later are opaque, complicated and very difficult to translate into practical politics. So both sides make large claims about the relatively small differences between them.
Ian Mulheirn says that this is all rather depressing, and he is right. He therefore suggests a useful package, which would increase taxation and cut spending in areas where the impact on demand is small, while also increasing infrastructure spending, where the impact on demand (and supply) might be fairly large. Since the infrastructure spending would be time-limited, this package would temporarily boost GDP, while also allowing the government to achieve the long term control over public debt which it desires.
The Mulheirn plan makes use of what economists call the “balanced budget multiplier”. The budget deficit does not change, but aggregate demand does. Since almost half of UK GDP passes through the hands of the government, there is plenty of scope to reshuffle the government’s tax and spending activities to impact both aggregate demand and long term productivity, without increasing public borrowing.
The specifics of the Mulheirn plan, though well argued, are perhaps less important than that central principle. It deserves careful consideration from the coalition.
Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.  He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.


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