David Blanchflower: Coming soon... the biggest U-turn yet as Osborne abandons austerity

Last week saw the first of what is likely to be one of many U-turns by the Chancellor as the economy continues to shrink. Taxes on pasties, static caravans and charitable donations that were introduced in George Osborne's disastrous and ill thought-out Budget were quickly reversed. Opposition to the measures, including a march of hundreds of bakers on Downing Street, had been gathering inside and outside Parliament. This is certainly not a Plan B as nothing here could be described as planned; this was a not so tactical withdrawal.

There was also a good deal of scrambling in the press to count up how many U-turns there have been over the last two years. The Labour Party claimed the number stands at 32 including forest sell-offs, free milk, school sports and aircraft carriers. None of this has been good for the Tories' poll ratings; the latest YouGov/Sun poll on 30 May had Labour with a 12-point lead. Unsurprisingly, tax cuts to the rich paid for by the poor haven't gone down that well. The Chancellor's economic credibility is in tatters.

The biggest U-turn that is headed our way though is the likely abandoning of the austerity strategy, as called for by economics Nobel Laureate, star blogger and New York Times columnist Paul Krugman who was in the UK publicising his new book End This Depression Now!* He provided support for an alternative narrative, that Martin Wolf, Jonathan Portes, Simon Wren-Lewis and I have been making for these many months, as a counter to the Coalition's spin that theirs is the only way. Mr Krugman's central argument is that we are suffering from a severe overall lack of demand.

We are in a liquidity trap, which occurs when injections of cash into the private banking system by a central bank fail to stimulate growth. His fix is for the government to spend where the private sector won't, and now. Eminently sensible stuff, especially when the UK can borrow at historically low rates of interest.

The question is not if but when and in what way Mr Osborne will have to put more stimulus into the economy as the pressure builds to reverse course. There is a question regarding who he will blame for the U-turn, which he will claim isn't one and was planned all along, even though it wasn't. The euro area is the top candidate, or maybe the Governor of the Bank of England who endorsed this policy. Infrastructure spending seems to be at the top of the agenda but that is unlikely to have much effect for a couple of years at least. Cuts to VAT and National Insurance seem the most likely candidates. Ed Balls is going to have a field day, saying he told everyone how this would work out, which he did.

This is all a long way removed from Mr Osborne's 2010 Mais lecture, given just before the election in February 2010 where he set out his Plan A. The title of the lecture was A New Economic Model. In it, he argued that he intended to move to what he called a new model of economic growth rooted in more investment, more savings and higher exports along with a supply side revolution, which hasn't happened. Despite his claims that his policies would "boost enterprise, encourage new jobs and show that Britain is open for business", the economy has stagnated. Unemployment is 150,000 higher and GDP is actually lower than it was when the Chancellor did his 2010 Spending Review.

The Mais lecture sets out Mr Osborne's belief in an expansionary fiscal contraction as a way of restoring growth in the UK economy. He even argues that the best way to get the rebalancing that will be required in the British economy "is tight fiscal policy, supportive monetary policy and countercyclical financial regulation". Well, the proof of the pudding is in the eating...

He set out eight benchmarks (some of them very vague) for economic policy, against which he said he expected to be judged: 1. Maintain Britain's AAA credit rating. 2. Increase saving, business investment and exports as a share of GDP. 3. Reform the banking sector and sell the state's stakes in RBS and Lloyds. 4. Improve Britain's international rankings for tax competitiveness and business regulation with specific measures on corporation tax and regulatory budgets. 5. Reduce youth unemployment and the number of children in workless households as part of a strategy for tackling poverty and inequality. 6. Raise the private sector's share of the economy in all regions of the country, especially outside London and the South East. 7. Reduce greenhouse gas emissions and increase the UK share of global markets for low carbon technologies. 8. Raise productivity growth in the public sector.

On these eight we have sadly seen little progress, and on some the situation is much worse than before Mr Osborne took office. Youth unemployment, inequality and poverty have risen sharply under the Coalition. There is little evidence of a rise in British competitiveness. The private sector has increased its share simply because of the cull of public sector jobs.

The AAA credit rating is under more threat now than at the time the Coalition took office as the economy was growing then but isn't now. There is also no sign of any resurgence in productivity growth in the public sector. The Treasury has not exactly been delivering value for money. He should be judged against these criteria, and the answer is one of failure. Put me right if I am wrong.

Perhaps the most important claim in the lecture was this: "A key lesson from the successful examples from around the world of fiscal consolidation is that you must be able to demonstrate that 'we are all in this together' in order to maintain a coalition for action". This may explain why we now have a coalition for inaction and dither.

Mr Osborne asked the question at the beginning of the lecture "are you better off than you were five years ago?" and argued that the answer to that must be "no". The answer at the next election to the same question now looks increasingly likely to be the same.

*Paul Krugman, End This Depression Now! WW Norton & Company, 2012