RELEASE DATE:
MONDAY 22 JUNE 2009

‘Lower taxes and spending cuts are the keys to overcoming recession’

The financial crash was entirely foreseeable, was made worse by abject policy failures by the government, and will only be cured by a long period of reduced taxes, balanced by public expenditure cuts.

That is the conclusion of a think-tank report, The Recession: Causes and Cures by Harvard-trained economics professor David Simpson, published today.

Causes of the crisis

According to Simpson, four major policy blunders contributed to the crash:

(1) For years, the British and American governments kept interest rates too low. They claimed they had ‘abolished boom and bust’. In reality, they were fuelling a huge bubble in the price of houses, shares, and other investments, and eventually, that bubble had to burst.

(2) Britain’s regulatory system, set up by Gordon Brown, focused on form filling – questions like how quickly a bank answered its customers’ phone calls – rather than looking at whether banks were taking dangerous risks. Like MPs, the banks obeyed the rules, but it didn’t stop the system collapsing.

(3) Implicit government guarantees encouraged banks to become ‘too big to fail’. They took dangerous risks because they knew that the government would bail them out if they got into trouble.

(4) Governments encouraged borrowing that people could not afford. The worst offender was the American government, which forced lenders to make home loans available to people with no record of creditworthiness. When house prices were booming, nobody noticed. When the bubble burst, the lenders were ruined.

Another reason why the banks took excessive risks, says the report, is that UK law gives too much power to boardrooms and not enough to shareholders – the people who actually own the business. This balance must be restored if future excesses are to be avoided.

Where do we go from here?

The only way to avoid crashes, says Professor Simpson, is to avoid creating booms. Now that the recession is here, the only way back to normality is to re-establish business confidence. And the best way to do that is to cut personal and corporate taxes, encouraging businesses to invest and customers to spend. But the government is trying to borrow its way out of the problem, which digs the hole even deeper and dents confidence even further.

Serious, long-term, confidence-building tax cuts will of course require equally drastic cuts in public expenditure. The Adam Smith Institute believes that the public is ready for such a programme, particularly when people look at the salaries, expenses, and index-linked pensions now enjoyed by public-sector employees.

The government’s flawed response

Professor Simpson says the government’s move to bail out the banks was a mistake which will prove harmful. Instead, some banks with large volumes of ‘toxic’ debt should have been allowed to fail, which would have left the others in a stronger position. The banks would now be lending again, and small businesses would have been able to borrow, and jobs would have been saved.

Furthermore, while there may be a case for targeted help to avoid the worst hardships caused by recession, a general financial stimulus package is likely to do more harm than good by preventing markets from adjusting to changed circumstances.
 
‘Quantitative easing’ – effectively printing money – will provide only a short-term stimulus, but will stoke up long-term inflation, says Simpson. The Bank of England does not have a good track record of keeping inflation under control.

Indeed, the whole crisis casts doubt on whether governments can actually be trusted with our money. They can print as much as they like, and enjoy the resulting fake boom. But, says Professor Simpson, we might be better off with money that is rooted in something governments can’t manipulate – gold, for example – which would save us from the politicians’ booms and busts.

Download a PDF of The Recession: Causes and Cures

 

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