A moment of realism
There are moments when realism finally impinges on the world of self-congratulation that is politics and broadsheet journalism, and yesterday was one of them.
It may turn out that the Office for National Statistics is wrong. That the figures being clung to in Downing Street are a better guide - tax receipts and the claimant count.
It may also be a blip, that 0.5 per cent fall in the output of the UK economy that happened in the three months when, traditionally, the economy booms. I will add that nobody predicted it: not the doomiest doom-monger.
Personally, as an inveterate counter of shopping bags in hands, of empty seats at the bar in my local pub, it did not feel to me like a minus 0.5 per cent quarter (compared with Q1 2009, which definitely did).
However, if the 0.5 per cent fall is not a statistical glitch, or a blip, it is a very sobering moment. Because it reveals the fragility in the UK economy even before the substantive reduction of public spending, which is set to take £110bn out of the economy in tax rises and spending cuts, has begun.
Two interventions by senior members of the policy elite that runs Britain highlighted important complicating factors.
First, the outgoing boss of the CBI, Sir Richard Lambert claimed the government has no growth strategy to offset the impact of the deficit reduction plan.
Then, last night, Mervyn King outlined the sheer scale of the collapse of spending power that the combined impact of inflation and wage restraint has produced. A 12 per cent fall in wages over the three years since Lehman; a six year period of stagnation since 2005, unparalleled since Britain's re-entry to the Gold Standard, and the defeat of the General Strike, flattened wages in the 1920s.
You can tell it is a serious moment because suddenly everybody in politics is fractious. The Labour shadow chancellor is ousted; the spinmeister general in Downing Street is ousted; frantic negotiations are taking place to assuage an Australian businessman based in America, causing several important people to miss Davos.
Let's take the three big problems facing the UK economy and look at the potential outcomes.
First, deficit reduction. If Britain had to act fast and decisively on the deficit, it was because of the size of the deficit, the lack of credibility of the Labour government and the Eurozone induced global sovereign debt crisis.
For the best part of nine months the need for rapid deficit reduction has gone largely unchallenged by the opposition because the new Labour leader wanted to set his political priorities out first, and mould an economic strategy to meet them, should he gain office in four years' time.
Now it is not simply the accession of Ed Balls to the job of shadow chancellor, but reality that is calling that apparent consensus into question.
Politicians of all stripes are having to face the question: is a possible double dip a price worth paying for deficit reduction?
Some are having trouble answering this in public but, philosophically, the Conservative part of the coalition has already answered it. It has always insisted deficit reduction comes before any impact on growth - arguing, as the OECD's Angel Gurria argued this morning, that in the longer term growth will come back stronger as a result.
But macro-economic policy is a two-edged sword: fiscal and monetary. George Osborne has repeatedly said that, in the event of a double dip, or of a slide back to stagnation which is more likely, the Bank of England should stand ready to do more quantitative easing: to print more money and keep interest rates low.
Two things now militate against that. First, inflation. King's speech last night was designed to soften us up for 5 per cent (and I think in that you have to read 6 per cent inflation).
Increasing numbers of economists - including people on the right as well as the left - believe there is already, secretly, an abrogation of the Bank's formal inflation target and that it would be best to get it out into the open.
Andrew Lilico, formerly of Policy Exchange, argues that the new mandate should be 2 per cent with a 2 percentage point band on either side (as opposed to 1 percentage point now).
King himself raised an interesting question last night, when he said it was against the Bank's remit to keep inflation on target in this situation:
"Of course, it is possible to argue that the current recession should have been even deeper in order to keep inflation closer to the target. But that proposition is one few commentators seem willing to embrace, nor is it consistent with the remit given to the MPC which states that "the actual inflation rate will on occasions depart from its target as a result of shocks and disturbances. Attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output".
This bats the ball back into the court of those who set the remit, who are, of course, politicians.
The second issue is the growth strategy.
Here's why it is important: in the run up to the election many Tories embraced the arguments of Mr Lilico and Policy Exchange that deficit reduction would, on the basis of both experience and economic theory, clear the way for a return to private sector-led economic growth.
This is the rebalancing story, or strategy and in the case of PX, as I have written before, it is postulated not on any kind of "hit and hope" attitude, but a well-argued theory, grounded in the work of Harvard professor Alberto Alesina.
They argued that British deficit reduction would have to go alongside further quantitative easing, and that, with caveats, this could stimulate growth even in the short term - though it would also boost unemployment:
"Macroeconomic modelling is complex, and always depends on the specifics of the country concerned. Nonetheless, we believe that it is of relevance that even the economies in our sample (with their - in most cases - much smaller deficits than the UK at present) found fiscal consolidation boosted growth even in the short term (and certainly did not undermine growth). It should also be noted, however, that even though periods of fiscal consolidation based on spending cuts are rarely, in our case studies, associated with exacerbating recessions, they do often coincide with rising unemployment."
The problem lies not with the authors of the above. It lies with politicians who have interpreted it as saying there is some automatic process whereby shrinking the state boosts the private sector: this argument is more closely associated with the work of Milton Friedman and Robert Barro.
Now there is a crucial difference. If you believe philosophically that the state gets out of the way, the private sector grows, you are not going to busy yourself writing a "growth strategy" full of micro-economic lever-pulling measures to make the latter happen. In addition you will see inflation targeting, and therefore monetary policy, in a far more hawkish light than that shone by Mervyn King on the subject last night.
So where is the government's growth strategy. Two days ago Sir Richard Lambert said this:
"Rather than a big picture of the kind of economic eco-system that the government wants to champion, we are left with a few rather vague ideas about the scope for supporting a number of predictable sectors, and the promise that more ideas will be forthcoming at the time of the spring budget."
Here's what I think is happening, and it's from as close to the horse's mouth as you can get. George Osborne scrapped the autumn growth white paper because the ideas in it were unimpressive. Instead what he's done is turn over to various departments the job of outlining sectoral growth strategies to be pulled together into the 23 March 2011 budget - pharma is owned by the Department of Health, transport by Transport, etc.
But Osborne acknowledges that the growth strategy is also balanced by various political commitments the Coalition parties have made - both to the electorate and to each other.
No third runway at Heathrow; an immigration cap; carbon reduction targets. The Treasury believes that, after yesterday, the see-saw will now tip towards growth and away from social policy, but the growth strategy does remain a compromise.
It is also a compromise with fiscal reality: you could, in theory, do a lot for growth by slashing taxes and business regulation but the deficit won't allow you in the first case, and Europe will not in the second.
The Coalition growth strategy is, in other words, philosophically conservative and liberal : it relies on removing obstacles rather than picking winners; it expects the decentralised parts to contribute to a synthetic whole. It is the opposite of dirigiste.
It may work but two problems present themselves. The first is timing: the Treasury and the Office for Budget Responsibility projections for UK rebalancing see a very rapid switch to investment and export led growth, starting this year.
That may happen - and if by late 2011 we are in an investment boom our only problem will be inflation and wages (see below). But if it is not rapid you are left with a growth gap and therefore potentially a fiscal gap.
It will not be long before somebody points out that, if the 0.5 contraction is consolidated into the 2011-12 growth projections, then the Budget might have to be more austere than expected.
The second problem is scale: Karel Williams of the Manchester-based CRESC has pointed out the huge obstacles to a tech and innovation led transformation: they defeated even the dirigiste government of Harold Wilson - another prime minister who saw Britain's deficit and currency problems being solved by a one-off voluntaristic march into the "white heat of technological revolution".
Since dirigisme failed, can a version of modern laisser faire succeed? As I've said before - probably not without some modern form of selective protectionism to go alongside it: for everybody is now in the game of trade delegations to India and China, and some of those in the game are perennially protectionist when it comes to growth policy.
Finally we come to inflation and the fall in real disposable incomes. It is this, not the impact of public spending cuts, or the snow, that is worrying policymakers.
If we have undergone a 12 per cent cut in real wages, and stagnation since 2005, then we are living through a sharp reversal of the "deal" on which financialisation was founded in the UK.
While in the USA credit more or less replaced rising wages in the 2000s, in the UK it did not; it went alongside a moderate rise in real wages, and had the effect of damping down inflationary wage demands.
Now the cheap credit age is over and so is the age of wage growth. Leave aside the implications of this for social justice, its implications for the economy are scary: because where does growth come from if the consumer is being hammered? (Incidentally I would discount the possibility of a wage-led season of discontent; not simply because of the weakness of the unions, but because financialisation has placed having a job above having a wage rise - employees will bargain their own wages down rather than face the possibility of life with a P45 but without a credit card, mortgage or monthly mobile phone bill.)
On consumption government here is ahead of the population: the OBR's scenarios for the recovery include a consumer boom as an unexpected negative: the recovery path needs the consumer to retrench, to save more.
But we may have miscalculated as to the sensitivity of consumer demand to this twin switch-off of disposable income growth and credit availability.
What does it all mean?
First, that the government will now have to scramble to fill in the gaps in its growth strategy. Second that monetary policy remains set on the course Mervyn King outlined: there will be no knee-jerk rate rises and there may even be more QE.
Third that the issue of bank lending becomes crucial. George Osborne remains confident he can get a deal with the banks - a transparent and monitor-able deal - that significantly boosts lending. One glance at any graph of M4 or M4 lending shows why this is crucial: the lending figure has collapsed into negative territory; the M4 figure itself (ex OFCs) turned upwards in mid-2010, from near zero, but I would like to see what it is now.
An economy with broken banks is like a machine with a dodgy dynamo: it is prone to cutting out abruptly and without warning. That's what I think happened in Q4, and like with an old-banger, the snow didn't help.
If the so-called Project Merlin does not deliver an agreement with the banks, and if they do indeed threaten to sling their hooks offshore, and resist to the hilt the FAT tax that is now building momentum within Europe and the G20, the results will be political before they are economic.
For, behind the scenes, the Liberal Democratss claim to be fighting tooth and nail for punitive sanctions on the banks and even - as Lord Oakeshott said on Newsnight last night - some form of socialised control of RBS and Lloyds Group.
If they fight and lose, and lose AV in the process, and then we get to the Vickers Report in autumn and any radical bank reform gets back burnered; and if we have any more quarters of negative growth, things will get even more tooth-and-nail inside the cabinet.