Economy needs a change of direction

Wednesday’s news that Britain’s economy shrank by 0.7% in the second quarter of 2012 has piled further pressure on Chancellor George Osborne to admit his plan A just isn’t working. It’s no secret we’re in debt – to the tune of £1 trillion and counting in fact – but the only way to ever hope of reducing that figure is by reviving growth in the economy.

Before Osborne’s first Autumn Budget statement in 2010 the UK economy was growing at an annualised rate of 2.8%, unemployment was falling and tax revenues had increased by £35 billion. This economic growth played a major part in reducing the deficit from £163 billion in April 2010 to £142 billion a year later.

At the time of the first round of Coalition spending cuts in April 2012, the deficit had slimmed down to £126 billion, meaning it fell by less during the financial year 2011-2012 (£16 billion) than in 2010-11 (£21 billion), and at the cost of a slump in GDP growth to just 0.2%, representing a loss in output of around £40 billion.

The forecasts for the financial year 2012-2013 don’t look any better. The International Monetary Fund has forecast GDP growth is at 0.2%, while the Confederation of British Industry predicts a budget deficit of £128 billion - a year on year increase of £2 billion.

These three consecutive quarters of negative growth can no longer be blamed solely on the previous government’s failings. The finger clearly now points at the current administration. It has gambled on an unprecedented programme of austerity, and lost miserably.

These are the deepest cuts since the 1930s and we are only an eighth into the planned programme. The government must now alter its course and focus on establishing the growth plan that has been lacking since it came to power. The UK economy needs direction but at the moment there is no one at the helm.

We are currently in a liquidity trap here in the UK. The private sector is deleveraging. Households, private sector companies and banks are all reducing economic activity and hoarding cash. In this environment the Government has no choice but to make good the difference. It’s not a choice; it’s an accounting law.

If this isn’t done quickly then the trap will only worsen. While banks refuse to lend and households spend less, any further government fiscal tightening will only lead to an eventual depression and collapse in economic output.

There is still time to turn this ship around. Record low interest rates make public investment a practical proposition. Just as the government has acted as guarantor of last resort for security staff at this summer’s Olympics, it must now abandon austerity and create the demand that the private sector has failed to deliver on.

Do you think the UK economy needs a change of direction? Please add your thoughts below.