Debt reduction and economic growth

Here’s a letter I wrote to the Evening Standard last week. I’m not sure whether they published it or not.

Too many people believe we have a choice between debt reduction and economic growth – that we can have one, but not the other. Nothing could be further from the truth. In fact, debt is the greatest threat to our economic stability and debt reduction is the surest route back to economic health. Recessions are painful, but they also play a vital role in the business cycle: as the excesses of the boom years are unwound, as bad investments are liquidated and debts paid down, solid foundations are laid for real, sustainable growth in the future. 

This has important implications. Firstly, it demands that George Osborne not only sticks with his deficit reduction plan, but actually goes further and faster. There is scope to do this. Remember, Labour raised spending by 60 percent while they were in office. The coalition government has so far reversed only the tiniest fraction of  this. Secondly, the government must stop artificially stimulating borrowing and let the necessary private- and financial-sector deleveraging take place. History shows that growth returns once this process is underway, and not before. The Swedish experience of the 1990s is a good example of this in practice. 

The Eurozone crisis paints a horrifying picture of what happens when debt spirals out of control, and Moody’s recent negative outlook warning shows that Britain is not immmune from the problems affecting the Continent. If we fail to reduce debt, the best we can hope for is Japanese-style stagnation. The worst case scenario – financial chaos and monetary collapse – is altogether less pleasant.

Perhaps I should have included a historical example of debt reduction going hand in hand with a return to economic health. One such occasion is the ‘forgotten depression’ of 1920, which Tom Woods writes about here:

The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent… Instead of "fiscal stimulus," Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third… By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923.