Both sides wrong on economy

In: Uncategorized

25 Oct 2010

This is my latest comment from Fund Strategy.

Both sides in the debate about the British economy’s future are living on forlorn hopes. Neither the free market nor the state provides any straightforward solution to the country’s woes.

Those who use free market rhetoric suggest that the private sector will thrive once freed from the state’s shackles. From this perspective, spending cuts will liberate the private sector to thrive.

Such arguments miss the reality that the idea of a free market, in the sense of the state playing a minimal role in the economy, is a myth. It sounds good in theory but the western economies do not work that way in practice.

For over a century all the developed economies, including America, have depended on heavy state intervention. Despite bouts of privatisation the levels of state spending have remained stubbornly high.

In addition, every capitalist economy has an extensive set of rules and regulations governing its activity. It is a world away from the ideal envisioned by free market doyens such as Milton Friedman and Friedrich Hayek.

In any case it is hard to take most free marketeers seriously. Few complained about the bank bail-outs in 2008-9 – state intervention on a massive scale.

However, those who see state action as a panacea are also likely to be disappointed. Simply pumping money into the economy to bolster demand will not solve Britain’s economic problems. Financing consumption does not in itself lead to greater production.

The Keynesian approach – it would be too flattering to call it a strategy – seems to be to continue with a fiscal stimulus and hope things come right in the end. It is based on the implicit assumption that Britain’s economic malaise is essentially cyclical – therefore ignoring its chronic weaknesses.

A subtle combination of state action and the private sector probably provides the best bet for overcoming imminent economic weaknesses. In particular, state policy would be better focused on promoting growth than on imposing austerity.

There are two obvious areas where the state could help bolster recovery. Investing in infrastructure rather than encouraging short-term consumption should help boost the country’s growth potential. There should be no doubt that Britain needs heavy investment in its transport and energy facilities.

The other key area is encouraging a culture of innovation and risk-taking. It would help if the state substantially reduced its excessive regulation.

A combination of the state and market working together to promote growth is the best bet for overcoming Britain’s immediate economic challenges.