The IMF Is Coming

Michael Burke writes:

The failure of the government's economic policy has led to a damning indictment from the International Monetary Fund. In the fund's flagship World Economic Outlook report it lowered the forecast growth for the advanced economies as a whole, but Britain by more than the rest. The IMF repeatedly singled out the British economy for weak growth and negative outlook. Its chief economist, Olivier Blanchard, said the UK chancellor, George Osborne, was "playing with fire".

If the IMF has become a severe critic of Britain's version of austerity, then things must be bad. Within the "troika", including the EU and the European Central Bank, the IMF has been a key architect of those policies in the bailout countries. Visitors to the soup kitchens of Greece, the poor of Cyprus who cannot access their savings and the Irish forced to leave their country must wonder what they have done to incur its wrath.

The IMF cannot produce an over-arching framework for its policies precisely because there is no intellectual justification for the different policies it pursues. In Britain the economy was experiencing a mild recovery before the coalition came to office. Stagnation since has seen the public deficit start to rise when economic policy is purportedly aimed at lowering it. The government's main response has been to prolong austerity to 2018. It is hard to avoid the conclusion that the IMF's criticism is a case of a rat leaving the sinking ship. No doubt other allies, such as the Office for Budget Responsibility, will do the same.

The ideological back of this government is broken and there is now no prospect of the Tories winning the 2015 election. In the main its representatives genuinely believe that removing the state from the economy would allow the resurgent private sector to take its place. They used to brief journalists about which taxes they would be cutting ahead of the 2015 election.

But severe criticism is emerging of one of the key tracts purporting to justify austerity policies. Harvard professors Carmen Reinhart and Ken Rogoff claimed that government debt of more than 90% of GDP was a magic number, leading to long-term lower growth or even contraction. This has no foundation in logic. Someone's debt is someone else's asset. Economic growth depends on the optimal deployment of assets, whoever owns them.

The criticism of both Tory economic policies and the academic justifications for austerity are emerging because the world economy is slowing once more. The endless consumer binge that is the US economy has slowed to a crawl in the early months of this year, partly in response to the mild austerity of $85bn in cuts and tax increases of the US sequester. British stagnation is widely expected to continue. The euro area economy is expected to contract in 2013. Current policies are clearly failing.

This goes to the crux of the entire debate on how to resolve the crisis. In Britain the source of stagnation is the decline in private sector investment. This fall in gross fixed capital formation exceeds the entire fall in GDP. Unlike Britain, the advanced economies as a whole have experienced a mild recovery from the slump. But the fall in investment remains the main brake on growth. The private sector is hoarding capital and refusing to deploy its assets.

Government spending cuts, especially cutting its own investment, only reinforce this hoarding of private capital. All schemes based on slower, shallower austerity run into the same problem. The crisis can only be resolved by addressing its source, the investment strike. Only government action can do that.