Analysis: Political taboos on the line as UK seeks to re-start growth

LONDON (Reuters) - British policymakers are looking for lessons from the depressed 1930s in their hunt for a way out of the country's longest slump since then - but the answer may not be what a government focused on fiscal austerity is hoping for.

Slashing Britain's massive budget deficit was the top goal when the coalition government took power in 2010. Now, however, economic growth is moving up the agenda.

Britain's economy is in its second recession in four years, and the euro zone debt crisis is casting an ever-darker pall over domestic firms' willingness to invest and create jobs.

Bank of England Governor Mervyn King has warned that the slump risks deepening as a result of this - and that the lesson of the 1930s was that private sector demand alone was not enough for growth.

Business Secretary Vince Cable, meanwhile, has said he hopes modest government incentives will be enough to kick-start a "1930s-style recovery" driven by private-sector home-building.

The comment raise the question of whether relying on the private sector is the right approach, or if the government needs to break its taboo of deviating from its austerity program to fund extra public sector investment.

"We are probably at the stage now where the markets realize that the main risk to the government finances is from the weak recovery rather than the government's willpower to bring down the deficit," said Vicky Redwood, chief UK economist at consultancy Capital Economics.

Eliminating almost all of a budget deficit of more than 11 percent of GDP within 5 years was the guiding light for finance minister George Osborne when Conservatives and Liberal Democrats formed a coalition in May 2010. But the surge in investment and exports they hoped would drive growth has not come, and there is little time for a new tack to bear fruit before 2015 elections.

So far, any shift in focus has been on reducing the cost of credit in order to spur investment, whether by Bank of England purchases of government bonds or a host of credit easing schemes.

The most recent "funding for lending" plan announced by Osborne and King offers banks the prospect of lower funding costs if they pass on the benefit in the form of new, cheaper lending to business.

However, similar plans have had little success in the past.

"There is something that smacks of desperation as there is scheme after scheme," said Pierre Williams from the Federation of Small Businesses.

POLITICAL VIRTUES

Williams reckons a lot of what ails Britain is out of its control.

"The elephant in the room is the ongoing euro crisis," he said. "There is no amount of initiatives that is going to overcome this concern."

The baleful effect of the euro zone crisis on business confidence is why some such as former finance ministry economist Ian Mulheirn argue that the government needs to step in and fund new infrastructure investment itself.

This is an argument that is also gaining ground in the euro zone itself, with Germany, France, Italy and Spain agreeing to a 130 billion euro package to boost growth.

But for now Osborne is relying on simply offering "much more" in the way of guarantees to reduce the risk of private-sector involvement in home-building and infrastructure projects.

The main advantage of this for the government it that they will not show up as government borrowing but as 'contingent liabilities' which it only has to pay if things go wrong.

But Mulheirn - who is now director of the Social Market Foundation think tank - worries further incentives will be needed, and that this will prove costlier than if the government were to fund the projects through issuing its own bonds.

"While the former might save some blushes it would be a lot more expensive than just using gilt-funded investment," he said. "Its main virtue is political. And for that reason we should be quite suspicious."

Britain's finance ministry takes a different view. While the country's cost of borrowing might be zero in real terms now, it could rise sharply if it were to damage market confidence in its commitment to deficit reduction by moving away from its plan.

PAIN THEN GAIN?

However, if the government does not want to take the route of issuing more debt, there is an alternative, promoted by Mulheirn and more tacitly by the International Monetary Fund.

Not all spending is equal. Some does a better job of adding to growth - in economics jargon, it has a higher multiplier.

By cutting spending that has a low fiscal multiplier, and using the proceeds to fund infrastructure, Mulheirn estimates that this could add an extra 700 million pounds to GDP for every 1 billion pounds of spending switched.

Spending that could be cut include free television licenses and heating subsidies for richer pensioners, as well as tax relief on higher-earners' pension contributions, Mulheirn suggested. The IMF mooted a further freeze to public sector pay.

All these areas may face cuts in future years to meet the government's deficit target, Mulheirn said. Cutting now - and using the proceeds on a more productive temporary investment program - would bring a growth dividend.

However, short-term political pain for long-term gain is unlikely to appeal to Osborne now.

Early last month, he had to reverse proposed tax rises on items including freshly baked pasties, a type of savory pie popular with poorer Britons.

And more recently he bowed to pressure and announced a surprise delay to an increase in fuel tax at a cost of around 550 million pounds. Government borrowing came out 3 billion pounds ahead of expectations at its latest count.

(Additional reporting by Matt Falloon and Sven Egenter. Editing by Jeremy Gaunt.)

Source: http://news.yahoo.com/analysis-political-taboos-line-uk-seeks-start-growth-080859516--sector.html

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