The International Monetary Fund’s annual investigation into the health of the UK economy makes ugly reading.
The IMF points out that “per capita income remains 6% below its pre-crisis peak, making this the weakest recovery in recent history … Capital investment (as a share of GDP) is at a post-war low, and that youth unemployment is high”. To top it all, the government’s austerity programme is another “headwind” against future growth and the risks remain “tilted to the downside”.
Although the ever-diplomatic IMF did not explicitly call for an abandonment of the chancellor’s fiscal Plan A, they call strongly for more public spending on investment severely slashed since 2010.
The IMF’s deputy managing director, David Lipton, was more upfront in the London press conference:
It would be, in our view, useful for the economy for infrastructure and other measures to be brought forward to reduce the drag of austerity measures … and provide more support for the economy.
In addition to demand boosting public investment, the support that is needed are the supply side policies recommended by the LSE Growth Commission.
The IMF and the chancellor: the special relationship
George Osborne has been a nervous man these last few months. IMF Managing Director Christine Lagarde is a friend, not least because the Chancellor pole-axed Gordon Brown as a contender for the IMF’s top job even though he was a fellow Brit. Lagarde paid him back through offering support for the Coalition’s austerity programme.
Even as the IMF as a whole was getting cold feet over the scale, shape and speed of UK austerity, the Coalition could rely on Lagarde – this time last year she presented the Article IV with much more enthusiasm for the government’s policies than the report itself. This year she was unfortunately unavailable, so it was left to her deputy to deliver the bad news.
Over the past year the IMF has become increasingly critical. In its April meetings IMF Chief Economist Olivier Blanchard said the UK was “playing with fire” with its current austerity programme.
The Treasury’s spin doctors have been working overtime ever since to say the IMF Article IV was likely to be very critical of the government due to internal politics. Hence when it came out as merely “critical”, the report can be dutifully hailed again as a ringing endorsement of government policy.
Article IVs are almost never directly critical of large countries like the UK, and they are always hedged in careful diplomatic language. Nevertheless the message is clear enough if you can read the runes - for example, see Jonathan Portes’ decryption of last year’s statement. This year is no exception.
Supply: a pressing need for structural policies
The strongest message was a ringing endorsement that “A number of initiatives identified by the LSE Growth Commission … should be pursued with greater vigour”.
These included: improving the human capital of low skilled workers through better training and education; overhauling the way infrastructure decisions are made and delivered through, for example, sharing development gains much more generously; and increasing competition in the retail banking sector.
The IMF stressed that these types of supply side reforms have benefits in the long run for raising potential growth, but also in the short run by improving expectations of future growth. Hence there is a double dividend for moving on these immediately instead of prevaricating, as the government has done over airports and energy, chilling private investment.
The government’s policy to stimulate housing through “Help to Buy” is rightly criticised by the IMF for stoking demand which would “ultimately be mostly house price increases that would work against the aim of boosting access to housing.” What’s needed is for the government to increase infrastructure spending to boost the supply of entry level housing.
Demand: more public investment, please
The IMF argues the UK is suffering from a persistent output gap, i.e. that the potential of the economy is far above current output levels. The implication is that monetary or fiscal measures to stimulate the economy will cause real growth and jobs, and not just higher inflation as supply side pessimists have been falsely arguing.
The IMF also makes the point that monetary policy has rightly been very aggressive, but this is not making its way through to credit. Since “planned fiscal tightening will be a drag on growth” the implication to be drawn is that some fiscal relaxing is possible, especially if used to bring forward capital investment. This is what is meant by “near term support for the economy”. When “labour is under-utilised and funding costs are cheap, the net returns” to public investment are very high. In other words, public investment right now is a no brainer.
Our anaemic growth over the past five years and chronic spare capacity obviously harms the UK economy in the short term, but it also damages our medium term growth prospects as people lose their skills and motivation, and beneficial investments lay unrealised.
The bottom line is that the IMF is endorsing an increase in public investment spending, as many of us have been pushing for years. The most effective way to address deficient demand would be for the government to directly spend at least £20 billion on infrastructure over the next two years, as analysed in studies by the Institute for Fiscal Studies, National Institute for Economic and Social Research and LSE’s Centre for Economic Performance, and the IMF now seem to agree.
I wish the IMF could have been even more critical of the failures of the government’s fiscal plans. They are too willing to accept the argument that “credibility” has been purchased by an excessively front-loaded deficit reduction plan, for example.
But it is clear that the chancellor’s (formerly?) favourite international think tank has signed up to the public investment programme we so sorely need. So perhaps we will finally get some real action.
A version of this article appears on LSE Blogs.