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first-stop-digging

Alistair Heath had an excellent ‘Editor’s Letter’ in the City AM last week. His main point was that the UK economy is currently being hit by two separate problems: the credit crunch (and its consequent downturn) and a “devastating drop in long-term competitiveness”.

I agree. And the problem is that in attempting to deal with the first problem (i.e. the recession) the government is almost certainly going to make the second problem even worse. That is to say the government is going to run up massive debts and (inevitably) raise marginal tax rates, damaging the UK’s economic competitiveness and hindering its long-term recovery, in order to increase spending in a misguided attempt to stimulate the economy.

This spending isn’t going to do much good because, as Russell Roberts puts it, the government “can no more stimulate the economy in the short run than you can make a child grow a foot in a week. Genuine growth takes time.” The only thing government can do is “help create an environment for that growth to take place by unleashing the creativity inherent in a nation’s people and those they trade with in other countries.”

This is key point: there is going to be a recession, it is going to be unpleasant, and there is very little the government can do about it. Years of cheap credit fuelled an asset bubble, causing capital to be misallocated; now that bubble has burst, the economy inevitably needs to adjust. Nobody wants to see companies go out of business and jobs lost, but government interference will only store up more trouble for a few years down the line.

Ultimately, the only thing government can really determine at this point is what kind of shape we’ll be in once the recession passes. Policy should be focused on the long-term health of the economy, not just motivated by a ‘something must be done’ mentality. For more detail on this, it’s worth having a look at Reform’s recent publication The Hole We’re In, which is one of the best things I’ve read on the subject.