This isn't what recovery looks like. Cameron's house price gamble will cost us all.

Cameron's recovery isn't really a recovery, and he's betting the house on a rise in the price of homes. This is exactly the mistake we made before the crash.

Peter McColl
1 October 2013

Conferences offer an opportunity for parties to enjoy direct access to the media. Parties use them to promote their most attractive policies. And that’s why the Conservative Party are using their conference to promote the early roll-out of the second phase of the scheme to help house buyers. This is very significant, as it both indicates the government’s future direction and its failure to deliver on growth in the productive economy.

The next election may well turn on the economy. There are several issues at play here. The first is whose fault the 2007-8 crash was. The second is whether there is a recovery. When coalition ministers speak an attack on Labour’s record is never far away. The contention is that Labour’s spending on schools and hospitals is what caused the crisis. And the crisis is the pretext to cut those services, social security and spending on other services that reduce inequality.

The question that most pollsters think will determine the next election is: “who is most economically competent”. And for Labour the troubling fact is that the electorate continue to blame them for the crash.

Of course there’s another story about unregulated banking, the power of the city of London and the destruction of British industry in favour of financial services that I think explains the 2007-8 crash. It’s worth noting that the Conservatives would have allowed Northern Rock go to the wall, creating a much larger crash than what actually came to pass. But arguments about regulation of banks, and the nature of post-Big Bang finance aren’t what I want to deal with.

I think that there are two key aspects of this debate. The first is the way in which the coalition is over-claiming the recovery. The second is that the nature of the recovery is insufficiently distinct from the pre-crash economy to avoid a future crash similar to the 2007-8 crash.

Is the recovery real?

At the Liberal Democrat conference Nick Clegg make a pitch to remain in Government after the next election. In this pitch Clegg made an argument. He claimed that only the Liberal Democrats could ensure that the recovery was fair in coalition with the Conservatives. And he then argued that if sharing government with Labour only the Liberal Democrats would stop their partners from killing off the recovery.

I’m not going to deal with the fairness that the Liberal Democrats bring to the recovery. I am going to look in some depth at what the nature of the recovery is.

Saying that Labour would kill off the recovery is a surprising statement. And it rests on an assumption about Labour policy that I’m going to accept. The assumption is that Labour will borrow to stimulate the economy, and while there’s not enough detail in Labour’s plans to suggest that’s what they’d do, I’m going to assume that they would.

The ‘recovery’ to date consists of three main elements. The first is a rebound in quarterly GDP, which has finally started to move above zero. The economy is growing again, and that’s being presented as a vindication of the Coalition’s policies. Of course, there are problems with growth that I’ll come back to later. But the key point here is that growth has returned.

The odd thing about what the coalition are doing is that the growth that has returned is pretty insignificant. The two consecutive quarters of growth may be a first for the coalition (it last happened in 2010 when Labour’s economic policies were still guiding the economy), but they are lower than what Labour achieved in their last quarter in government in 2010. This was performance which the Conservative leadership derided as “economic failure”.

You can see the figures on a graph here.

So what’s happening isn’t actual growth or a recovery. It’s the Coalition talking up the economy. They’re doing this in the hope that they can take advantage of perceived gains in wealth through increasing consumption, higher house prices and the positive impact on jobs that these changes will create. When you add the rebound from demand suppressed during the great recession it seems like very little of a recovery at all.

If this is a recovery of sorts then it won’t be stopped by Labour’s approach of stimulus. If anything, a stimulus is likely to accelerate growth as spending on infrastructure and spend-to-save projects (like the 2009 boiler scrappage scheme) gets people into work and spending. The problem is that stimulus creates more debt. But this debt can be offset by the tax income from the activity generated. So what did Clegg mean when he said Labour would put the recovery at risk?

Clegg is either trying to reinforce Labour’s reputation for poor economic management or he believes that the threat of an increase in debt to fund a stimulus will stop people from spending. I don’t know anyone who stops spending because they are worried about the sum national debt. I know lots of people who don’t spend because their jobs are at threat or because they don’t have a job.

By claiming a recovery and building economic confidence the Coalition are storing up more problems for later. Storing problems up for later is, ironically, the basis of Clegg’s criticism of Labour’s approach to the economy. But slightly higher levels of debt are unlikely to be as much of a problem as what the Coalition is doing to engineer a recovery.

Growth ignorant of the lessons of the past

The Westminster political consensus is that growth is a precondition for social and political success. It’s for that reason that the government staved off recessions after the dot-com bubble burst and after the attack on the Twin Towers by lowering interest rates and stimulating consumer spending and property debt. Rather than allowing smaller recessions to stall house-price growth or reduce consumer confidence, there was a ‘long boom’. This combined with increased tax-take from banks that produced ever larger profits created the impression of perpetual, virtually frictionless growth.

Growth continued quarter after quarter, and as it did people were willing to spend more on buying houses. The more willing people were to spend the higher prices went. As prices rose so banks lent more. And this inflated house prices further. Until house prices became a bubble.

Screen shot 2013-09-30 at 18.29.05.png

House prices to median incomes (via an animated version of this map, showing how these figures have changed since 1997, see the matteroffacts blog, form which this snapshot comes)

Even those who weren’t moving house managed to cash in. People quickly realised they could borrow against the increased value of their house to fund consumer spending.

What should have been a minor headache after the dot-com bubble, or a day ruining hangover after 9/11 was seen off with ‘hair-of-the-dog’ drinking the next morning. Instead of slowing the housing bubble the Bank of England acted to keep pumping it up.

The Coalition came to power seeking to solve this problem in two principal ways:

1. Reducing the size of the public sector;

2. Increasing the productive capacity of the economy through export-led private sector growth.

They have failed in this. After two and a half years of stagnation, it became clear that their analysis was wrong. Where they believed that the public sector was ‘crowding out’ the private sector, and that once business was free from the dead hand of public spending it would begin to grow its exports, they have been disproven. This seems to be because the long years of consumer led growth substantially reduced the latent productive capacity of the economy. Larry Elliot discusses why this is in some detail.

Reducing the national debt, which was the Coalition’s other stated aim has stalled because there has been no return to growth. And of course any reduction to the national debt is being offset by increases to private debt. The argument that national debt is bad, while private debt is good is one that is difficult to sustain.

Which brings us to this week.

Because cutting public spending failed to stimulate the private sector into generating export led growth, the government went back to what it knew best. It decided to encourage house price growth as a way to unleash consumer spending. The timing of this is important because it is targeted at ensuring there is a period of growth before the 2015 election.

Whether the fundamentals are strong enough to sustain this growth long enough to make a difference remains to be seen. But what is certain is that it is not Labour that is a threat to the recovery. It is the Coalition government, whose policies are a return to the ‘hair-of-the-dog’ economics of the last decade.

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