Why Budgets are bad news for the economy

March 20, 2012, 01:20am

LIKE many economists I will be busy tomorrow covering George Osborne’s third Budget. For once, it seems like it could be quite radical. However, I won’t be poring over the fine print trying to distinguish between the populist gimmicks and the parts that will really matter. Instead, I will be arguing that Budgets are a distraction. The last thing I want entrepreneurs to be doing is devoting time and resources to listening to politicians.

According to the economist Robert Higgs, the chief explanation for the duration of the Great Depression was what he calls “regime uncertainty”. The basic argument is that private investment declined so heavily because investors became uncertain about the scale and scope of future government intervention. They therefore withheld investment, channelling their efforts towards political, not economic calculation.

There is plenty of evidence that regime uncertainty is playing a role in the recent recession, but politicians still fail to grasp that their policy responses, though they may aim to give greater confidence, often leave markets more unsure of the future than ever. The minutes of the Monetary Policy Committee’s February 2009 meeting provides a possible example: “the government’s announcement in mid-January of a five-point plan to tackle the problems in the UK banking system had initially had little impact on market sentiment. That also possibly reflected the fact that financial market participants were waiting for more detail on the plan.”

Unfortunately, Osborne also has form – the ever-changing, ill-judged bank levy was exactly the type of arbitrary and counterproductive policy that stifles recovery and undermines the investment climate. However, his steadfast commitment to the coalition’s deficit reduction plans are a welcome attempt to make government policy more predictable. Indeed, despite my misgivings with the government’s present actions, there is something to be said for consistency.

In an ideal world we would see plans for flatter (and lower) taxes, reductions in employment regulations (which fall most heavily on small and medium-sized enterprises) and more genuine efforts to reduce the public debt burden. However, all policy changes come at a cost.

So tomorrow may see revolutionary announcements, but I’ll be hoping for some boredom in the Budget as well. I hope that if the chancellor really does have his own radical plans, he doesn’t introduce them in a way that disrupts entrepreneurial plans that are being made today, destabilising further the fragile recovery. He should not try to kickstart the economy; he simply needs to lay the ground rules to let it flourish. Small steps in that direction are more welcome than grandiose plans that fail to deliver.

When it comes to budgets, remember two things: the microclimate affecting any given business is more important than the general economy, and just because politicians can influence the economy does not mean that they can control it. But, sadly, this doesn’t stop them trying.

Anthony J. Evans is associate professor of economics at London’s ESCP Europe Business School.



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