Britain Faces a Lost Decade, Deeper than Japan’s

Thursday’s IMF report has shown conclusively that George Osborne’s Plan A has failed. Austerity is pulling Britain back into recession.

The International Monetary Fund (IMF) has long been an advocate of fiscal retrenchment and market-oriented “neoliberal” reforms. Indeed, the IMF is in part behind the current austerity programs currently being imposed upon Greece and Southern Europe, and from the start was a supporter of the UK Coalition government’s stringent brand of austerity.

This makes the IMF’s latest report all the more shocking. The IMF concludes that the “fiscal adjustment has restrained growth”, shrinking the economy by a cumulative 2.5% in the two years since 2010.  This before the bulk of the spending cuts have even begun.

As regular readers will know, many economists have already concluded that austerity is strangling the recovery before it has even begun; indeed the economy is weak enough to seriously jeopardise attempts to cut the deficit. Nonetheless, it is significant that the IMF, the architect of austerity, has now come to the same conclusion.

And once again, the IMF has downgraded its estimates for Britain’s future growth. The new figures would imply Britain’s lost decade will be deeper than Japan’s. Given that Japan never recovered even close to 1980s levels of growth, this is a particularly bleak outcome for Britain. In reality, it may be decades before Britain recovers- a lost generation may be a more apt description.

Economist Duncan Weldon has an excellent article on the Touchstone blog, comparing the new figures against Japan’s lost decade. As we now know, Japan’s lost decade turned more into a lost generation; the country’s economy has never truly recovered. The outlook for Britain is bleak: UK growth is likely to be even lower.

Britain's growth outlook is worse than Japan's lost decade

I’ve pointed out the similarities between Britain’s crisis and Japan’s in a previous article. In Japan, banks were left unreformed, and money pumped into them fed the so-called “zombie-economy” of debt-ridden businesses, prevented from failing. The similarities go deeper than this. Duncan Weldon points to a comment by Paul Krugman in his book The Return of Depression Economics,

The slowness with which Japan’s economy deteriorated was in itself a source of much confusion. Because the depression crept up on the country, there was never a moment at which the public clamoured for the government to do something dramatic. Because Japan’s economic engine gradually lost power rather than coming to a screeching halt, the government itself consistently defined success down, regarding the economy’s continuing growth as a vindication of its policies even though that growth was well short of what could and should have been achieved. And at the same time, both Japanese and foreign analysts tended to assume that because the economy grew so slowly for so long, it couldn’t grow any faster.

So Japan’s economic policies were marked by an odd combination of smugness and fatalism – and by a noticeable unwillingness to think hard about how things could have gone so wrong.

The IMF urges Osborne to change course

Yet, the IMF has gone even further: the report urges George Osborne to change course, and to slow down the rate of austerity. The IMF suggests a looser monetary policy to begin with, and if growth does not pick up within another year, then some sort of stimulus beyond “fiscally neutral” measures is needed to prevent “permanent loss of productive capacity”.

The IMF makes it very clear: a slowing of austerity would not trigger problems from the market:

Some further slowing of consolidation is unlikely to trigger major market turmoil

43. Further slowing consolidation would likely entail the government reneging on its net debt mandate. Would this trigger an adverse market reaction? Such hypotheticals are impossible to answer definitively, but there is little evidence that it would. In particular, fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence. Though such simple relationships are only suggestive, they indicate that a moderate increase in the UK’s debt-to-GDP ratio may have small effects on UK sovereign risk premia (though a slower pace of fiscal tightening may increase yields through expectations of higher near-term growth and tighter monetary policy).  This conclusion is further supported by the absence of a market response to the easing of the pace of structural adjustment in the 2011 Autumn Statement. Bond yields in the US and UK during the Great  Recession have also correlated positively with equity price movements, indicating that bond yields have been driven more by growth expectations than fears of a sovereign crisis.

The IMF suggests the government take advantage of Britain’s historically low bond yields to invest in the economy. The bond yields are at such a low level precisely becauseof the poor growth in the economy (not as a sign of strength, as the government has argued). To quote Jonathan Portes, Director of the National Institute of Economic and Social Research,

First, the reason long-term gilt yields are low in the UK (and similarly in virtually every other “advanced economy with monetary independence”) is weak growth, not “confidence” or “credibility”.  “Bond yields are driven more by growth expectations.”  That is, yields are low not because of economic confidence but because of its exact opposite.

The Eurozone cannot be blamed: Britain is performing worse than Europe

As I pointed out in a previous post, the evidence from across the Western world shows that those countries cutting fastest are experiencing the lowest rates of growth. The IMF’s figures add further weight to this. Although the British government have been eager to blame the Eurozone crisis for the continuing slump, the British economy is actually performing worse than the overall Euro area. And both the Eurozone and Britain are performing far worse than the USA, which is cutting its overall deficit far more slowly.

The UK's recovery has been worse than the USA and Eurozone

Of course, as Ben Bernanke and Paul Krugman famously said, “They say ‘there are no atheists in foxholes.’ Perhaps, then, there are also no libertarians in crises”. Osborne has begun to privately change course: the rate of cuts has been slowed, as the IMF acknowledges, monetary policy has been loosened even further and a £40bn “stimulus” has been announced. This does not go far enough: the “stimulus” has only involved underwriting private sector loans, no new capital has been provided. Far more radical action is needed.

The evidence is now clear. The outlook for Britain’s economy is dire: this crisis will be deeper than Japan’s lost decade, and longer even than the Great Depression. The UK government’s ideological decision to opt for a program of particularly stringent austerity is responsible for a large part of this. Things must be dire indeed when even the IMF, for long an advocate of such austerity programs is now urging the government to turn back.  It’s time for George Osborne to abandon “Plan A” and adopt a program of Keynesian stimulus.


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