Is pessimism justified?

By Roger Bootle

It isn’t only that the immediate outlook looks grim but also that they can apparently see no way out. Yet throughout the post-war period, economists have tended to think that there is always a way out – and they have been trained to try to find it. Is the current abject pessimism justified?

As far as the immediate outlook is concerned, it is. Events have vindicated those of us who foresaw just how difficult recovery would prove to be. But still I am somewhat puzzled. After all, what ails us is not destruction wrought by war, earthquake or famine. Human beings and their institutions got us into this mess; why can’t they get us out of it?

Of course the uber-pessimists do think that what has happened is something like a natural disaster, albeit human in origin. They believe that the financial crisis of 2007/9 effectively wiped out much productive capacity. As in all the best myths – and all the worst economics – there is a grain of truth in this. But even advocates of this view concede that there is also currently a strong element of weakened demand. Many economists, myself included, suspect that this is just about the whole story.

So why can demand not be stimulated? Much of the answer concerns a clash of interests and views. Take the euro, for instance. The euro crisis is holding back economic growth across the world. The solution for the euro is either to mend it or end it. But which? Either would require deep insight from political leaders and the skill and determination to push through an immensely complex negotiation between conflicting views and interests. But it was the politicians who created this problem and they who need to get us out of it. Don’t hold your breath that the latest sticking plaster has solved matters.

Here at home, countless people, including yours truly, have urged a programme of increased public investment. What holds the Government back? Surely it cannot still believe that public austerity automatically brings private sector recovery.

What holds the Government back is mainly the fact that the Chancellor not only adopted “austerity” but aggressively supported it in the face of opposition from Ed Balls. If Mr Osborne were to adopt Plan B now this would look like an admission that Balls was right. Unfortunately, from where things currently stand, it looks as though he was. Again it is the politics that get in the way. Yet can Mr Cameron not find a solution? A form of words to act as a figleaf? Or even moving Mr Osborne to another senior job?

Many commentators have also urged on the Government a policy of deregulation and tax reform to galvanise economic activity. What holds the Government back? Fear of the political consequences when the Lib Dems viscerally disagree with so much of this programme. Over to you, Mr Cameron.

A large part of the economic problem consists of the weight of past mistakes on the present. This is the case with the banking system. Banks are not lending partly because of bad assets hanging over from the past. And that is surely the essence of why others are reluctant to lend to them, or invest capital in them.

The solution must be to unshackle from the past. Establish new banks, publicly funded if necessary, with new balance sheets and new people, unweighed down by the mistakes of the past, and/or to find new ways of finance that bypass the banks. Too much interventionism? Too much ideological baggage, more like it.

Across the world, deficit countries need the surplus countries to increase spending. The latter seem to be saying: “thank goodness the leak isn’t in our part of the boat”. Yet with the international financial system, we really are all in this together. Again, this comes down to a political problem.

Capitalist economies are a strange mixture – needing little or no macro management in normal times, but every so often absolutely relying on the state to pull them out of depression. This requires the most audacious leaders that democracy can throw up. The crisis is as much about the inadequacies of our political system as it is about the scandalous behaviour of the banks.

There is much in the present mixture of defeatism, complacency and misguided financial orthodoxy that conjures up the 1930s. The worst thing is the confusion of human and institutional failings with God-given inevitability. Across the democratic world, voters may yet coalesce around some sort of solution. I hope that it isn’t the sort of solution that so many of them found attractive in the 1930s.

Roger Bootle is managing director of Capital Economics. Telegraph