Shadow chancellor believes his decision to follow John Maynard Keynes and oppose consensus on deficit has been vindicated
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Ed Balls believes his warnings about cutting the deficit have come true. Photograph: Murdo Macleod for the Guardian
There are only a handful of people in Britain who think they can get away with comparing themselves to John Maynard Keynes without provoking guffaws.
Ed Balls is one of those people. In the most important speech in last year's Labour leadership contest, Balls drew comparisons with the father of modern macroeconomics to explain why he was opposed to Britain's two deficit reduction plans. These were: George Osborne's plan to eliminate the stuctural deficit over the course of this parliament, outlined in his emergency budget in June 2010, and Alistair Darling's plan to halve the deficit over four years.
In his speech on 27 August last year at Bloomberg, Balls explained that he was happy to stand outside the consensus because there were examples in the last century when "dissenting voices of economists were silenced or ignored". Two of the examples cited by Balls involved Keynes:
• The decision in 1925 by Winston Churchill, who was then chancellor, to return Britain to the Gold Standard on the grounds there was no credible alternative. This was opposed by Keynes "at the fateful 11 Downing Street dinner where Churchill made the decision".
• The decision in 1931 by Ramsay MacDonald, the Labour prime minister, to impose spending cuts to reduce the deficit. This was opposed by Keynes.
In his Bloomberg speech, Balls had a vivid phrase to explain why it was wrong of Osborne nearly 80 years later to cut spending so far and so fast to tackle the deficit:
George Osborne was fond of saying – wrongly – that the Labour government had failed to fix the roof while the sun was shining. What he is now doing is the equivalent of ripping out the foundations of the house just as the hurricane is about to hit.
Balls showed, in his response to the chancellor's autumn statement on Tuesday, that he feels vindicated when he revived the language of his Bloomberg speech:
We said that the chancellor's plan was reckless, not cautious, and that he was ripping out the foundations of the house, leaving our economy not safe, but badly and deeply exposed to the growing global storm.
The remarks by Balls highlighted the two dividing lines (a favourite phrase of his mentor Gordon Brown) that will define British politics between now and the general election:
• The dividing line between Balls and Osborne. Balls believe that Osborne's Plan A – the elimination of the structural deficit – has failed. The chancellor admitted on Tuesday that he will not achieve his original ambition – to achieve this by the 2015 general election. Osborne says he will still meet his original fiscal mandate – the elimination of the structural deficit and ensuring that debt is falling as a share of GDP – within the timeframe of his "fiscal mandate" by 2015-16. But Balls says that the first part of this is a "dodgy rolling target", assessed on a five yearly basis, which means that there is never a definitive point where a judgment can be made on the deficit.
Balls said that by cutting too far and too fast the chancellor has sucked demand out of the economy. This has slowed the recovery and led to an increase in borrowing by £158bn.
Osborne believes this position is ridiculous. His thinking was reflected in the Times on Wednesday by Daniel Finkelstein who wrote:
Ed Balls ended up yesterday arguing that we are borrowing too much and that the way to borrow less is to borrow more...I promise you, this is never going to work politically. Ever.
• The dividing line between Balls and supporters of Tony Blair and David Miliband. Blairites believed that Labour should have acknowledged the concerns of voters about the size of the deficit. This is why they fervently support the Darling plan to halve the deficit over four years – a tough plan which would have led to around 80% of the coalition's cuts.
Balls believes Labour has no need to apologise because the bulk of the deficit was racked up by the increase in spending and the fall in tax receipts during the recession of 2008-09. Balls also believes, as I blogged in September, that it is wrong for an opposition to lock itself into a specific economic plan such a long time before the next general election.
The shadow chancellor believes his warnings in his Bloomberg speech are coming true. But he also believes that what he now calls Osborne's "catastrophic error of judgment" – the assumption that the private sector would pick up the slack as the public sector shrinks – is now clear from an examination of a speech by the chancellor to Bloomberg. This is what Osborne said in his speech on 17 August 2010, ten days before the Balls speech:
Here in Britain we can start to be cautiously optimistic about the economic situation. GDP growth in the second quarter surpassed expectations at 1.1%, with all but 0.2% of that coming from the private sector.
Employment is growing at the fastest pace for over a decade, confounding predictions that the economy cannot generate private sector jobs. Manufacturing is picking up and exports are recovering thanks to increasing global demand.
As the Bank of England confirmed last week, this is consistent with the kind of gradual recovery forecast by the Office for Budget Responsibility at the time of the Budget. The much-needed rebalancing of our indebted economy - away from government and towards the private sector, away from consumption and towards business demand, away from imports and towards exports - is beginning.
Osborne did strike a cautious note:
But of course, we must remain cautious. Inflation is proving more persistent than expected, as the Bank of England Governor explained in his letter to me this morning. The availability of credit to support business expansion is limited and needs to improve.
Despite the strength of the German economy, data for Japan and the US has been less encouraging, undoubtedly contributing to lower global confidence. And of course, the world remains concerned about sovereign debt issues at a time when our budget deficit remains the largest in the G20.
So I agree with Mervyn King when he said last week that we are likely to face a choppy recovery. To expect a smoother ride after the biggest economic crisis of our lifetimes, and with the debt problems this government has inherited, would be asking too much.