Why George Osborne Wont be Able to Repeat Geoffrey Howe’s Post 82 Recovery

Tory support heading down towards 25%.  Economists writing to newspapers describing how cuts will drive down aggregate demand and feed a spiral of decline.  Grumbles and splits in cabinet about the need for a plan B.

Not just today but the situation Geoffrey Howe experienced in 1981.

George Osborne’s prescription and ideology has always been to repeat the ‘supply side revolution’ of 1982-1987, where growth at one point hit 3.5%.

Although critics will immediately note that this recovery was largely job free as unemployment continued to increase until the late 1980s.

Note that the big bang didn’t occur until 1986 it was irrelevant to this period of growth.  What was important though was a rise in north sea oil revenues and a fall in the value of the £ to more competitive levels against the dollar.

North Sea Oil Revenue

There was a major difference though between then and now.  The deregulation of buildings societies led to a private sector credit boom which offset to a large extent the falls in public sector borrowing.  This led to a a house price boom and house building boom – egged along by Nicholas Ridley imposing national housing building targets at the regional level.  82-86 saw house prices increase at bubble like nominal  levels of over 10%/annum.

This nominal rise – fuelled by a high capacity to increase lending by the equity value of building societies – was increase by finally getting inflation under control during this period.  So housing became an increasing store of value.  In 1982 Q2 the real average house price was £65,217 having fallen for four straight years.  By 1987 Q2 it has risen to £90,858 a rise of 39%.  Housebuilding rose from around 190,000/annum in 1982 (which incredibly by today’s low numbers was a the lowest number of completion’s since the 1920s) to around 240,000 annum by 1986.  Indeed the growth in private bank/building society credit during this growth was such that by 1985 the Treasury had given up the ghost on monetarism and attempting to control the money supply by controlling state money.

Osborne benefits neither from oil exports or housebuilding booms.  There is no dramatic fall in cost push inflation, no major productivity increase in labour (though in the 80s the evidence was this was due to layoffs), no major growth in self employment (though again in the 1980s the evidence is that this was due to layed off people becoming self employed as demand recovered rather than a rise in self employment).  The evidence from the 80s was that other supply side measures such as Enterprise Zones had almost no net effect on output simply diverting employment growth and reducing tax receipts.   Privatised industries grew but because of higher monopoly prices and the prior recovery  in demand.

Osborne is trapped because far from an increase in private sector credit to offset public sector deleveraging we have simultaneously public and private sector deleveraging.   No economy can grow if both sectors are deleveraging at the same time – a double balance sheet recession.

Growth in the private sector requires investment.  As Schumpeter wrote investment can come from two sources – Robinson Crusoe type savings – money stashed away to one day spend on investment, or through bank credit extended on the basis of future profits.  Today we have the private sector piling up its balance sheets yes but with no signs of profitable investments to spend it on.  Lowering interest rates does not increase this type of investment as it does not come from borrowing but savings, indeed if interest rates are low these kind of savings become forced as alternative relatively risk free assets are hard to come by.

Indeed the Austrian story of growth through investment funded by savings, which Osbourne and his friends abide by,  has a fatal flaw.  As theory it only works if the investments and savings are overlapping as if everyone saves at once, as most private firms with positive balance sheets are doing, then aggregate demand falls.  If saving is done in an overalpping way the saving by one firm reducing demand is offset by the result of an investment of another leading to higher output (through higher productivity) and net growth to the economy.

As ever Osborne’s world view is that of the household or firm spending and borrowing not the effects of all households and firms collectively.

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