Newspaper Article

Fairytale thinking is the great survivor of the financial crisis

Date: 19 March 2018
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Publisher: \News International

As well as being notable for the first spring statement, last week was also notable for being the tenth anniversary of the last pre-crisis budget. For readers under 30, pre-crisis refers to a time when earnings and funding for public services were rising. We expected and usually got economic growth at 2 per cent a year and more. If you had savings you could get interest on them.

At that moment in March 2008, months before the collapse of Lehman Brothers and the most dramatic loss of national income in modern history, Alistair Darling, the chancellor at the time, felt able to tell the country that “because of the changes made by this government to entrench stability and to increase the flexibility and resilience of our economy, I am able to report that the British economy will continue to grow through this year and beyond”. If only. The forecasts from 2008 make sobering reading. Had the economy grown as predicted, and continued on its path, national income per person might be nearly £6,000 higher than it is today. That is a mighty loss in expected welfare.

Instead of carrying on as before, the British economy has gone on to break unwanted record after unwanted record. The deepest recession and slowest recovery since the 1920s. The worst decade of earnings growth since at least the 1860s. The lowest interest rates since the Bank of England was founded in 1694. The biggest deficit since the Second World War. The biggest increase in public debt in peacetime, pushing it up to double pre-crisis levels.

This history matters. It is too easy to forget the extraordinary nature of the period we inhabit in among the minutiae of this week’s inflation numbers and next week’s revision to the latest growth estimates. It is too easy to forget that, pre-2008, it would have been inconceivable that a chancellor would have felt it possible to have put a Tiggerish gloss on growth forecasts that never exceed 1.5 per cent a year. Growth forecasts that miserable simply did not happen in the halcyon decades preceding the crisis. A decade without earnings growth did not happen once during the 20th century. Cuts in public service spending on the scale seen since 2010 have never happened before. Never in living memory has it been so hard for young people to buy a house. Cuts in social security benefits affecting so many working-age people are a new phenomenon.

So if people are unhappy with the way the economy is going, and want to take it out on the political class, we should hardly be surprised.

But there is another lesson to learn from this history. It is in the dangers of magical thinking. There was quite a lot of that pre-crisis. Gordon Brown famously announced that he had abolished boom and bust. The economic cycle was gone forever. This time it was going to be different. It wasn’t just politicians engaging in this epic bout of self delusion. I remember being told by extremely senior economists involved in policymaking that macroeconomics had essentially been solved, that with an independent Bank of England, an inflation target and a set of fiscal rules all would be well. That macroeconomics was now boring. Of course this time was not different. Brown had not abolished boom and bust any more than had Nigel Lawson, his equally hubristic predecessor as chancellor in the 1980s. Both thought they had found the key to permanent economic success. Both were proved wrong in dramatic and costly fashion.

If a period of apparent success breeds one form of magical thinking — a belief by policymakers in their own infinite wisdom and ability to bend the economy to their will — then a period of economic difficulties breeds different forms of magical thinking. And I’m not talking here about debates over the speed of deficit reduction or the speed at which interest rates should now rise. Reasonable people can and do disagree over those. I’m talking about a more fundamental unwillingness to confront reality. There’s a lot of this about, too.

One strand is evident among those who believe that leaving the single market and customs union can make us better off economically. It will not. Making trade with by far our biggest, richest and closest trading partner more expensive will not have net economic benefits.

Then there are those who seem to believe that all our public spending needs can be solved by printing money, that in the long term extra tax revenues are not needed. Or those who think that there are many tens of billions of tax revenues that can be painlessly magicked from the vastly rich and from multinational companies. Or those who believe that letting the free market rip and building a new tax haven off the coast of Europe will solve our problems, and we can have both low taxes and world-class public services. Or those who believe widespread nationalisation is a panacea.

In the face of years of poor economic performance these sorts of delusions are perhaps understandable. But delusions they are. The truth is less exciting and more mundane and harder work. Successful economies are built not on unlimited spending or unfettered free markets or fetishes with nationalisation or privatisation. They are built on the careful design of regulations — of the financial sector and of utilities, however they are owned; on effective and inclusive education and training policies; on efficient and progressive and broad-based tax policies; on judicious decisions over where to invest public money; on good governance and effective institutions. Boring I know. But then reality was always less exciting than fairytales.

This article was first published by The Times and is reproduced herein full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist.