Double-dip recession: There's always fantasy island

A beach in Zanzibar, Tanzania
Image caption The sunshine of economic recovery has so far failed to matterialise

There's a parallel universe I always go back to when we get big GDP figures, as we have with today's announcement that Britain is in a double-dip recession.

In that parallel universe, the British economy recovers rapidly on the back of a shrinking state, booming exports and a rapid switchover to high-tech manufacturing.

Stay with me for a tour of this alternative reality: The economy is now recovering rapidly, at 2.6% per year, following a very decent 2.1% last year. Exports are booming - the positive trade balance contributing a third of the growth, even as government spending and investment slumps. Oh, and CPI inflation is 1.9%.

Every week at PMQs, Ed Balls sits with his head in his hands, ruing the day he ever read a Keynes textbook…

Now, that parallel universe is based on something very real and tangible. It is the original projection of the Office for Budget Responsibility in November 2010, which George Osborne used to justify the biggest fiscal austerity programme Britain has seen in 60 years.

Almost every aspect of the OBR's vision has been proved wrong.

Even though manufacturing has recovered fast, it has nowhere near made up for the destruction wrought during 2009-10, so output is below where it was when Lehman went bust.

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Image caption The eurozone has been something of a headache for the markets

Meanwhile the world economy, which was recovering faster than expected in 2010, has slowed down, and Britain's key export market, the eurozone, has tanked because of disastrous leadership and the naked pursuit by Germany of its own self interest.

Last November, two years on, the new OBR leadership presented George Osborne with a much bleaker picture: So much damage had been done that rebalancing would not be rapid; growth would not return rapidly. The "output gap" was so large that there would have to be even more austerity even to meet the target George Osborne set himself, and then conveniently moved. Moreover, consumer demand was being flattened by imported inflation, the result of the lower pound engineered by Mervyn King at the Bank of England in numerous Eeyore-like appearances.

At that moment Mr Osborne had a choice. The IMF had left him an open door to respond to any deterioration by cutting taxes. It said that if the economy deteriorated:

"Some combination of the following would need to be considered: (i) expanded asset purchases by the Bank of England and (ii) temporary tax cuts. Such tax cuts are faster to implement and more credibly temporary than expenditure shifts and should be targeted to investment, low-income households, or job creation to increase their multipliers."

Asset purchases - ie expanded money printing by the Bank of England - we have had. Tax cuts we have not. On 29 November last year George Osborne set his face against that kind of Plan B, in favour of a Plan A++, which involved extending the period of cuts for two years and raising the amount clawed out of the economy by austerity from £111bn to £147bn by 2017.

That's why I described it as "a turning point in British history": Osborne rejected one form of conservative response to slowing growth - tax cuts - in favour of a policy mono-focused on balancing the books in five years time.

A consistent theme throughout this past 12 months has been the absence of a growth plan that actually delivers growth. The Conservatives' instinct was to go for a rapid breakup of labour market impediments to growth: mass exemptions for small businesses from minimum wage rules, reducing entitlement to maternity leave etc and unfair dismissal. This was the focus of the Beecroft report. The Lib Dems stymied it, leaving the government, as Vince Cable said in a leaked letter, without a coherent strategy.

"There is still something important missing - a compelling vision of where the country is heading beyond sorting out the fiscal mess; and a clear and confident message about how we will earn our living in future."

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Media captionThe global economic recovery has sparked growth in manufacturing and consumer spending in Lincoln

The government will argue, correctly, that a huge amount of our current woe is the result of the collapse in confidence and in global credit conditions engineered by Mr Sarkozy and Frau Merkel. It will point out - as I have pointed out on Newsnight, in my report from Lincoln last month - that there are pockets of success where industry has oriented itself to high-tech, export-led growth.

The challenge for policy now is what to do about these new conditions. Quantitative Easing is a strategy running out of road. The only "upside" to the persistent high inflation is that it is wiping out the savings of the old, as opposed to the job prospects of the young. But that, as they say, is not the sort of upside you really want when there is a huge demographic bulge of over 55s in the electorate.

You could cut taxes, as demanded by various industry federations, slashing corporation tax or massively increasing capex exemptions: but that would involve accepting the risk that the UK loses its AAA rating (as France and the US have done).

Supporters of tax cuts might argue that we will lose our AAA rating anyway if growth fails to materialize - because even the new, revised and realistic OBR projection has growth at 0.8% this year (it will struggle to meet that) and a combination of consumer spending and a soaraway investment boom from 2013 onwards. This too begins to look like fantasy island.

The fact is, even in this depressed world situation, economies that are export oriented, high-tech and can expand domestic services - including mixed-economy health services - are growing.

The initial premise of George Osborne's austerity programme turned out to be wrong. The real problem is if the premise of his longer, deeper austerity plan is also wrong, and that Vince Cable is right.

What will the government do? It's hard to get them into a TV studio at present but we'll let you know.

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