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Chancellor must change fiscal policy

IT was all meant to be so different, at least in the mind of Chancellor George Osborne.

But after a 0.3% tumble in Gross Domestic Product (GDP) in the final three months of last year, revealed yesterday, the UK now stands one quarter away from triple-dip recession.

Manufacturing output plunged 1.5% in the fourth quarter of 2012. So much for the chancellor's vision, proclaimed confidently in his March 2011 Budget, of a "Britain carried aloft by the march of the makers".

After Mr Osborne took fiscal austerity to a whole new level in his debut Budget in June 2010, hiking the scale of annual public spending cuts and tax rises to be in place by 2014/15 by £40 billion to £113bn, there were enough wise economic heads shaking in disagreement if not despair.

Back in 2010, David "Danny" Blanchflower, visiting professor at Stirling University and a former member of the Bank of England's Monetary Policy Committee, told The Herald that the Conservative-Liberal Democrat Coalition Government's slashing of public spending was an "inept action" and "the greatest macroeconomic mistake in 100 years". He declared the Coalition's strategy was based on "a belief system, on dogma", rather than on a flexible way of responding to the economic data.

Yet Mr Osborne, standing at the despatch box delivering his first Budget in summer 2010, appeared utterly confident that some very rosy-looking growth projections from his Office for Budget Responsibility creation would come to pass.

This was somewhat odd, given that looking past any political ideologies, what would actually transpire on the back of his economic policies appeared to be a matter of simple arithmetic.

What appeared to escape Mr Osborne and his team, and continues to escape them, is that if you suck a huge amount of demand out of the economy it is unlikely to deliver any meaningful growth.

And, in terms of depressing demand in the economy, Mr Osborne has pushed all the right buttons.

Welfare spending has been one of his main targets. Most of those who have already been, or will be, affected by these cuts have to spend all of their money to live. So these cuts will feed pretty much straight through to aggregate demand.

Strathclyde University's Fraser of Allander Institute has been among those to warn about the huge impact of these welfare cuts on the Scottish economy.

Mr Osborne also hiked value-added tax. This again hits disproportionately those on lower incomes, who have to spend most, if not all, of their money, and therefore also reduces demand significantly.

However, it is not just the consumer side of the economy which has been running for cover from Mr Osborne and his policies.

With the chancellor claiming the UK was on the brink of bankruptcy when the Coalition came to power, drawing bizarre and unhelpful parallels with Greece, and consumers reining in their spending amid job losses and widespread fear of unemployment, business confidence also tumbled.

There has been talk that the recent snow raises the danger of a further fall in UK GDP in the current quarter.

And it was not as if the economy, given the current state of it, needed its man-made woes to be compounded by trouble from the natural world.

The UK's recovery from the deep recession of 2008/09 proved short-lived. The economy fell into double-dip recession – contracting during the period from October 2011 to June 2012 – before temporary factors helped it rebound in the three months to September.

Recession constitutes at least two consecutive quarters of falling GDP. Between the UK's 2008/09 and October 2011 to June 2012 recessions, GDP fell in a single quarter in the final three months of 2010.

Yesterday's GDP figures, from the Office for National Statistics, showed the services sector, the biggest part of the economy, stagnated in the fourth quarter. Construction output rose by 0.3% in the fourth quarter, but was down 11% on the same period of 2011.

The Scottish Chambers of Commerce warned this week the economy north of the Border would likely flatline in broad terms this year, after further falls in activity in the manufacturing, construction, retail, wholesale distribution, and tourism sectors in the fourth quarter of 2012.

It argued talk of triple-dip was not helpful. It viewed the Scottish economy as bumping along the bottom, and pointed out, whether there was a small contraction or a modest rise in GDP in any given quarter, the key point was there was no significant recovery.

While a 0.3% fall in GDP in the fourth quarter is significant enough, and a triple-dip must absolutely not be dismissed lightly if it occurs, Scottish Chambers' argument holds some merit.

If UK GDP does not contract in the first quarter, things will still feel grim for most people and businesses. The bottom line is the promised recovery has not materialised – and we have waited a long time.

And it is not as if we need a triple-dip recession to confirm the Coalition's macroeconomic policies have failed. They have been, as Mr Blanchflower, warned in 2010, a huge mistake.

The National Institute of Economic and Social Research describes the economic mess we are in as a depression, and this definition seems ever-more appropriate.

The Coalition focused on cutting corporation tax, but what we really needed were measures which put money into the pockets of consumers, not out of them. Consumers can then spend it, and boost hard-pressed businesses.

Mr Osborne, who made keeping the UK's AAA sovereign credit rating a key aim, made the mistake some businesses have made by failing to see the impact on the top line of slashing costs.

With the UK on the brink of a triple-dip and economists polled by Reuters now putting the chances of a loss of the AAA rating this year at 60%, a more appropriate fiscal policy stance and mix is long overdue.

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