George Osborne‘s handling of the economy was strongly attacked byLarry Summers as the former US Treasury secretary poured criticism on the UK’s austerity programme, its welfare cuts for poor people and its strategy for preventing a housing bubble.
Summers, a long-running critic of the coalition government, said the chancellor was wrong to blame the eurozone crisis for the weakness of business investment and that governments should be spending more on infrastructure to tackle the threat of “secular stagnation”.
“I see less need to impose cuts on people who are vulnerable in the US context than the chancellor sees in the European context”, Summers said in a session on the future of monetary policy at the World Economic Forum in Davos.
Making it clear that he believed Britain would have done better to follow the US approach in which tackling the budget deficit has been seen as less important than restoring growth, Summers said: “It’s several years since the US exceeded its peak GDP before the crisis – that still hasn’t happened in the UK.”
The chancellor put up a staunch defence of his approach, noting Britain was creating jobs, had sound economic policies and a new system for controlling the City that was the envy of the world. Osborne said businesses had been sitting on their cash while the euro was going through “a near-death experience” but predicted that investment spending was now about to start to rising.
The chancellor responded to Summers’s charge that Britain, unlike the US, had failed to raise national output above its pre-recession levels by saying that the UK had suffered a deeper slump and was more dependent on the financial sector for its growth.
“We did have a much bigger fall in GDP [than in the US], and the impact of the crisis was even harder because our banking sector was a larger share of the economy than in America.
“The great recession in the UK had an even greater effect – and we were one of the worse effected of any of the western economies.”
But Summers, the man once a front-runner to succeed Ben Bernanke at the Federal Reserve responded to Osborne’s claim that the Bank of England had tools to rein in the property market by pointedly rubbishing the initiative.
“I worry about macro-prudential complacency”, Summers said, a reference to the notion that central banks can head off problems before they arise by actions to restrain the animal spirits of lenders.
Noting that policymakers had failed to spot the stock market crash of 1987 and the sub-prime mortgage crisis, Summers said he was unclear about how macro-prudential policies would work and said tougher measures were needed to make markets safe from “ignorance and error”.
Osborne said he agreed with the need for more infrastructure spending, but added there was no “free lunch”. Governments needed to take tough decisions elsewhere in your budgets, in areas such as welfare spending.
“Without a credible fiscal policy, as many other countries learned in this crisis, you don’t have a credible monetary policy and your market rates go up.
“So while infrastructure spending is needed, you need to make hard choices as finance minister as how to pay for it.”
Summers rejected Osborne’s argument that high borrowing costs in troubled eurozone countries were the result of governments over-spending and losing the trust of financial markets.
He said high borrowing costs were due to the specific nature of the eurozone currency – the fixed exchange rate and the inability of individual countries to tailor their economic policies to their own needs.