Can governments still steer the economy?

LONDON — In 1969, the British financial journalist Samuel Brittan published a book called Steering the Economy: The Role of the Treasury. At the time, it was still widely assumed that the United Kingdom’s economy was steerable and that the Treasury (which was still in charge of monetary policy) was at the helm.

Back then, the Treasury’s macroeconomic model, which calculated national income as the sum of consumption, investment and government spending, effectively made the budget the regulator of economic performance. By varying its own spending and taxation, the Treasury could nudge the UK toward full employment, real GDP growth and low inflation. Subsequent models, influenced by the monetarist and New Classical revolutions in economic theory, have since reduced the state’s capacity to intervene. Yet the belief that governments are responsible for economic performance still runs deep.

The UK’s recent budget announcement is a case in point. When presenting his budget to Parliament this month, Chancellor of the Exchequer Jeremy Hunt sought to reassure lawmakers that the government is on track to tame inflation, reduce debt, and boost economic growth. Hunt even went so far as to present detailed predictions for each of the next five years. As he put it, “We are following the plan, and the plan is working.” Yet, it has long been clear that inflation and growth depend on global trends over which the British chancellor has no control.

The fact is that international finance, technology, and geopolitics rule out any possibility of “steering” the UK economy. While these variables were regarded as stable (or at least predictable) parameters of national policymaking as late as the 1990s, today all three are considered a source of exogenous shocks, unpredictable or unexpected events, with the potential to spoil any budget forecasts.

No UK policymaker, for example, predicted the global financial meltdown caused by the 2008 collapse of Lehman Brothers. Likewise, no one can foresee the repercussions of the recent failure of Silicon Valley Bank and Credit Suisse, especially in an era when every possible effect of every disruptive economic event is amplified on social media. And with heightened geopolitical tensions threatening global supply chains, the models on which policymakers like Hunt rely are becoming increasingly obsolete.

Specifically, the relationship between fiscal and monetary policy is veiled in mystery. The reigning economic model assumes that controlling inflation is a necessary and sufficient condition for macroeconomic stability, and that inflation is primarily caused by budget deficits, or “governments printing too much money”. With that in mind, the government outsourced the task of steering the economy to the Bank of England (BoE) in 1997, while the Treasury remained in charge of balancing the budget over a five-year forecast period and reducing net debt to a sustainable level.

The combination of BoE independence and fiscal discipline was supposed to assure markets that politicians would not go on spending sprees. But, given that the BoE has been printing as much money as politicians want since the start of the COVID-19 pandemic, the separation between fiscal and monetary policy has become largely fictional, along with the stability and prosperity it was said to ensure.

Hunt should have looked to US President Joe Biden for more creative economic thinking. Biden’s Inflation Reduction Act, which includes $370 billion in clean-energy subsidies, is based on an almost-forgotten macroeconomic idea known as the balanced-budget multiplier: higher public spending can be paid for by raising taxes on the rich. Biden’s stated policy is still to balance the budget, but this approach would enable him to do so while boosting spending, rather than adopting the sort of austerity policies UK governments continue to pursue.

Biden’s economic policy represents a welcome return to the old Keynesian view that aggregate demand matters. By contrast, Hunt’s plan to boost economic growth depends entirely on remedying so-called structural (or supply-side) deficiencies.

The UK’s puzzling labor shortage underscores the inadequacy of the British government’s approach. The number of unemployed people is 1.3 million, and millions more working-age Britons are not employed or actively seeking work. Yet many businesses are struggling to find workers, with job vacancies jumping to 1.1 million. Hunt’s answer is to increase incentives for the “economically inactive” to rejoin the labour market. But in practice, he is encouraging people to apply for jobs that do not exist.

The reason is that despite supply bottlenecks in sectors such as retail, hospitality, and agriculture, the economy as a whole is experiencing a deficiency of aggregate demand. Given that the British economy has still not recovered to its 2019 level, and that consumption has fallen while the population has grown by 1.7 million between 2020 and 2023, this should not come as a surprise. Yet, the government’s latest budget makes no mention of boosting aggregate demand for labor, either on the consumption or the investment side.

In late 2020, former UK Prime Minister Gordon Brown and I proposed a scheme whereby the government would guarantee a job and/or training to anyone who could not find work in the private sector, at a fixed hourly rate not lower than the national minimum wage. This, we argued, would be the quickest way to boost aggregate consumption in the economy without resorting to complicated forecasts about the size of the output gap. As John Maynard Keynes once said, “Look after unemployment and the budget will look after itself.”

On the investment side, Hunt announced the creation of 12 investment zones free from the burdensome regulations that supposedly stifle entrepreneurs’ “animal spirits”. In concentrating on these supply-side measures, however, Hunt has missed an opportunity to beef up two nascent publicly-financed investment institutions: The UK Infrastructure Bank, which was set up in June 2021 to provide finance for projects to tackle climate change and support local economic growth, and the British Business Bank, created in 2014 to fill the financing gap for small businesses. By enhancing public investment, the government could improve business expectations and divert investment from speculation to critical green-energy projects and regional development.

At a time of global turmoil and heightened uncertainty, the national budget’s primary purpose is not to steer the economy to the point of imagined stability. Rather, policymakers must use fiscal policy to protect the least well-off from disruptive external blows and to achieve maximum strategic autonomy in a world that is spinning out of control.

Robert Skidelsky, a member of the British House of Lords, is professor emeritus of Political Economy at Warwick University. Copyright: Project Syndicate, 2023. www.project-syndicate.org