UK becoming a Banana Republic?

The IMF report was not good news. It reduced its expected growth in the UK from 2.5 in April 2010 to 1.5 in May 2011. This after a period of 0 growth (-.5 in the last quarter of 2010 and .5 in 2011 1st quarter). It also said that the course being pursued for deficit reduction (mainly cuts) should not change UNLESS there is a prolonged period of weak growth, unemployment and inflation. There are many signs that we are headed for exactly that: a prolonged period of slow growth.

On 11 May, the Governor of the Bank of England, Mervyn King, claimed that government austerity measures and the squeeze on household incomes, due to the rise in VAT (a regressive tax that affects the poor more than the rich) and inflation, will cause consumption to be weak for at least the next 2 years. So where will growth in demand come from? Not from households. And not from a shrinking Government.

Will it come from the business sector? Many corporations are hoarding their cash, not spending on R&D: leading companies like Pfizer are leaving (going to Boston due to its stronger research base), and banks are providing little lending, especially to SMEs. Thus the 2011 budget, with its emphasis on reducing both taxation and regulation does not seem to have affected the private sector’s ‘animal spirits’. Just their pockets. But we already knew that would happen from the failure of the 1980s tax cuts to ‘trickle down’ to households. The emphasis on ‘enterprise zones’ is another unfortunate return to the 1980s, a battle between regions to attract capital –not as Science Parks do (selling knowledge and skills), but as places like the Caribbean basin did in the 1980s, attracting capital based on the promise of low taxes, weak unions, and weak regulation.

What the UK should be listening to is the CBI call in 2006 for turning the Technology Strategy Board into a US-style DARPA (Defense Advanced Research Projects Agency)—where massive state investments produced the internet and later fuelled Silicon Valley. The algorithm that led to Google is not the outcome of a ‘private sector’ led initiative, but a public sector National Science Foundation grant. And today’s large investments in green technology are mainly being made by State initiatives in Japan, Germany, the USA and South Korea, with the UK falling behind most European countries. The private sector works best when the public sector is strong not weak.

So is the UK becoming a banana republic, trying to attract capital through cheap measures like tax reductions, rather than through its investments in human capital, training, science and technology? One would think so not only by the lack of serious investments in these areas in the last budget, but also by how much attention Osborne is giving this week to the opinion of the IMF—known for worrying about economies in the developing world, and prescribing standard cut-and-paste recipes for lowering interest rates and inflation. The IMF is the world’s leading financial institution. It cares, like all lending institutions, a lot about inflation because when it lends one pound, it will get back a pound with less value if there has been inflation.

It is thus no surprise that the types of recipes that it has provided the world are not about those investments needed to produce long run growth (which sometimes also causes inflation), but about deficits, interest rates, taxation and inflation, which effect bonds and the value of loans. These problems should not be ignored but they should not provide a guiding principle. In fact, the few counties that have grown in Latin America and in many of the ‘emerging’ parts of the world (e.g. South Korea), are precisely those that turned their backs on the IMF policies that called for spending cuts. The austerity plans in Ireland have hardly produced growth. Germany is confidently spending its way out of the recession, especially on research and education, and growing as a result, not following any IMF plan or anxiously waiting for an IMF verdict.

The IMF has already had to (unapologetically) correct its growth predictions for the UK and will soon have to correct its green light on austerity since a prolonged period of slow growth will be even more clear in the coming months. The government should not sit back and wait for this to happen but move quickly and think carefully about a Plan B that focuses on creating those conditions that will produce innovation, good jobs, and long run growth, and listen to those institutions and countries that have a record for doing so.