David Cameron’s red light zone is closer to home than he thinks

WARNING WARNING. Thomas Hawk, CC BY

When discussing the state of the economy, politicians deploy two key tricks. First, get your excuses in early. Second, take all the credit for any good news but blame others for any bad news.

David Cameron has used both devices when he warns that “red warning lights are flashing on the dashboard of the global economy” with the UK’s fragile recovery threatened by external forces, most notably: the euro-zone crisis; a slowdown of growth in the emerging markets; and geopolitical tensions. So, is the prime minister’s intervention good economics or just good politics?

Structural austerity

The economic storms in the euro zone have had, and will continue to have, a major impact on the UK economy. The euro-zone countries are the UK’s major markets and slow or negative growth in these areas has an adverse impact on UK exports. But the case of the euro zone also illustrates the wider problems of systemic austerity. The problems of the euro zone reflect its structural flaws: combining different countries together in an economic framework which leaves little or no flexibility to deal with economic problems such as recessions and unemployment.

When countries suffer slow growth, the traditional remedies include fiscal expansion, monetary stimulus and depreciation of the exchange rate. But the euro prevents these remedies being used effectively. Depreciation is simply not possible, for a start, and don’t be fooled by the monetary stimulus of the European Central Bank – the real interest rate is much higher in those euro-zone countries with the biggest problems. Fiscal rules, meanwhile, serve to limit the scope for counter-cyclical policy. The structure of the euro zone requires austerity for the system to survive. The UK has more flexibility about economic policy; its austerity is a political choice.

Emerging prospects

PM playing the game. World Economic Forum, CC BY

As the prime minister pointed out, growth in the emerging economies has been slowing down. The “good news” here is that the UK does little trade with many developing nations so this slowdown should only have a minor impact on the economy.

The bad news is that growth will return to many emerging markets, and the UK will continue to have little presence in these markets. By 2050, China’s economy is estimated to be around five times its current size and India’s should be around eight times larger. They may be misfiring right now, but Cameron should be in no doubt that these economies will help to drive world economic growth – and the UK may be set to miss out on many of these new opportunities.

The conflicts in the Middle East and the Ukraine are a genuine worry. As Cameron said, they are “adding a dangerous backdrop of instability and uncertainty”. But these problems are largely local or regional and although they are not conducive to growth their economic impacts are not – yet – global in reach.

Closer to Home

While stuck in front of the lights, the prime minister proclaims that: “Britain is not going to waver on dealing with its debts.” This is a partial, incomplete notion of the country’s debts. The coalition government is myopically focused on public sector debt – which it has failed to reduce – while ignoring private sector debt.

This reflects dogma, not economics. Public sector debt is considered “bad” but private sector debt is considered “good”. So consumers borrowing to buy a fridge, car or new holiday is fine. But the public sector borrowing to invest in education, health and infrastructure is frowned upon. This can lead to such absurdities as using a state-owned French firm to build a nuclear reactor (Hinkley Point C) using Chinese money rather than the cheaper option of using public sector borrowing.

This dogma has led to a major imbalance in economic policy with fiscal policy being too tight and monetary policy too loose. The recovery has been dependent on consumer debt and house price inflation. We don’t need long memories to realise that this is a recipe for a crisis.

David Cameron has identified some of the warning signs in the global economy. But he is conveniently blind to the red lights flashing at home.