Will Osborne’s shock therapy kill or cure the English patient?

Britain’s new chancellor of the exchequer, George Osborne, has this week come in for stinging abuse from neo-Keynesians, left-wing commentators and opposition Labour MPs who are enraged by his decision to “supplicate before the market Gods” and “recklessly endanger Britain’s economic future” by imposing an austerity budget on Britain last Tuesday, 22 June.

The Financial Times commentator Philip Stephens wrote: “Mr Osborne, like his counterparts across most of the western world, is in the thrall of the financial markets. The biggest risk, he said more than once, was that Britain would be caught up in the sovereign debt crisis. Thus have the markets – and the rating agencies – reclaimed their hegemony over public policy.

As the Nobel laureate Paul Krugman others have argued, politicians such as Osborne are needlessly imperilling their countries’ economic futures by withdrawing stimulus measures before recovery is assured.

US president Barack Obama is warning European governments that budget-slashing at this sensitive time could jeopardise global recovery. Is the preference that governments should continue to luxuriate in a tub of debt and turn a deaf ear to any brouhaha from “the markets”?

But Osborne has plenty of supporters. Given the UK ‘s debt/GDP ratio rose to 70% in fiscal year 2009-10 and is expected to climb above 90% within four years, they fear without spending cuts and tax rises, Britain could end up as another Greece.

The new frugalists argue that, if the UK were to carry on adding to its already immense debt burden by borrowing even more to maintain spending at a time when tax revenues have collapsed, it would have been “severely punished ” by the markets, inflation would rise, and it would risk losing its AAA credit rating.

This faction simply cannot understand how a government that is already up to its neck in debt could hope to resolve the situation by … er … borrowing even more. The argument is that Britons can’t expect to continue benefiting from Rolls-Royce public services and welfare provision on a Mini Minor budget and believe the country’s best hope is to face up to reality now.

Simon Jenkins, a columnist in the Guardian, is firmly in this camp, even though it is likely to put immense strain on the coalition between Tories and Liberal Democrats. But Vince Cable, the business secretary and a former Shell economist, wrote on Comment is Free there really wasn’t any choice after years of Labour profligacy

Cable wrote: “The government is united in accepting that its first duty is to clean up the fiscal mess it inherited. Not any old mess but a great, steaming pile of manure. Someone has to remove it. We can’t just hide the smell beneath the perfume of optimistic forecasts or rely on natural decay. It would be easier to blow a raspberry at the malign forces of financial markets and the capricious judgments of rating agencies. But rational policymaking must be based in the world as it is, not how we would like it to be…”

Osborne’s “tough but fair” Budget comprised a £40bn package of emergency tax rises, welfare and benefit cuts and public expenditure restraint – all designed to rebalance the UK’s books by 2015.

The bigger “bloodbath” lies ahead, however.

The coalition government’s comprehensive spending review, due this autumn, will detail plans for axing public expenditure by 25% by 2015. That implies massive job losses ad public service cuts, and therefore a huge rise in unemployment, which will further reduce the government’s revenue-raising powers and bump up its costs. The consequences, warn the neo-Keynesians, include a Japan-style “lost decade”.

However, some commentators are already detecting signs of light at the end of the tunnel.

Iain Martin, writing in the Wall Street Journal Europe, said he is convinced Osborne’s vision extends beyond being a mere axeman towards rebalancing the UK economy, for example by replacing excessive public spending with export-led growth. “Through the gloom Mr. Osborne thinks there are better times ahead. In austerity he sees an opportunity to dismantle the superstructure of the Brownite state—and to simplify the tax system.”

Maybe Osborne’s long-term plan is to reinvigorate the UK by reinventing Thatcherism for the 2010s? Perhaps he is using the cover of the current “fiscal emergency” to dismantle the country’s generous welfare state, in the hope of jolting some Britons — dubbed “benefit scroungers” by our “red top” tabloid newspapers — out of their torpor in the hope of turbocharging entrepreneurialism.

It is clearly too early to know whether Osborne’s experiment will work, or whether the neo-Keynesians are right and it’s all going to end in tears. We won’t know if Osborne’s tough medicine has killed or cured the English patient for a few years yet.

This is an edited version of a blog post published in Qfinance on 24 June 2010.  This version published on 26 June 2010