The General Election announced today will be the most important for decades. Whoever emerges as Prime Minister next month will face two challenges above all: securing the economic recovery, and reducing the government deficit. How they handle these inseparable concerns will profoundly affect the strength of the British economy, the welfare of the British people, and the equity of British society. Is it true, as the Conservatives and Liberal Democrats claim, that Labour’s high deficits before the recession caused the recession, and that its subsequent policies have deepened it? Or, rather, did Labour navigate the economic storms with courage and sound judgement? Most importantly, which party can we trust to secure Britain’s recovery?

It is important, first, properly to understand the relationship between a weak economy and high public deficits. The recent contraction in the economy was caused by a collapse in demand from the private sector. Financial institutions had loaned too much money that could not be paid back, so the banks either failed or were forced to reduce their lending to consumers and businesses drastically as debtors defaulted en masse. Similarly, many individuals and households became insolvent and were compelled to reduce their spending as well. As consumption and business investment declined rapidly, first output and then employment began to fall. The rate of inflation also fell, indicating that this was a classic demand-side recession pushed by a collapse in the private sector. The Conservative claim that Labour’s expansionary fiscal policies before 2008 pushed the economy into recession, then, cannot be true. High public spending stimulates demand as the government pays for services rendered or goods purchased from private companies, and hires new employees to do work for the state. Since the recession was caused by falling demand, Labour’s policies, which increased demand, cannot have been responsible for the contraction.

Once the contraction had begun and the grave extent of the problem became clear, the loan guarantees and other measures taken by the government to stabilise the financial system were crucial in preventing a depression, as followed the 1929 financial collapse. Heeding the lessons of that experience, the government and the Bank of England acted correctly to preserve lines of credit, without which a modern economy cannot survive. Without a functioning financial system, hundreds of thousands of employees dependent on businesses being able to get loans to pay wages or purchase materials, millions of people with mortgages, and millions more with savings would have been placed at great risk - far greater than was incurred by the assumption of public debt. There were abuses that must be and are being addressed, but we should realise that banks are essential for the creation of wealth and the coordination of savings and investment.

Given the severity of the recession in the autumn of 2008, it was certainly correct for the Labour Government to introduce a fiscal stimulus package, a move opposed by the Conservative Party. The government’s logic was sound: private sector demand was falling rapidly and could not without help sustain the economy. Public spending and tax cuts would put money into the economy quickly, shoring up demand to prevent a more precipitous fall in output and a steeper rise in unemployment. The Conservative argument against the fiscal stimulus was that the UK could not spend more money without increasing the cost of borrowing, and lengthening the recession by damaging business investment and financial confidence. In fact, the government bonds retained their triple-A rating, positive growth resumed in the fourth quarter of 2009, and unemployment has remained below 8% with a little less than 2.45 million unemployed, defying forecasts of a 10% unemployment rate. This last statistic is particularly telling: unemployment has remained substantially lower than it was during the recession of the early 1980s, when it topped three million, and the recession of the 1990s, when it almost reached three million – even though that recession was less severe than the present one. Business failures and home repossessions, despite the catastrophe of the housing market, sit at just half the rate they were in the 1990s, and some of the credit must go to the government’s efforts to support these sectors through fiscal measures. David Cameron claimed it was Labour’s policies that lengthened the recession and meant that the UK did not return to growth in the third quarter of 2009, pointing to the fact that the United States enjoyed positive growth in the third quarter. In fact, the only mark against the Government’s fiscal policy is that the stimulus was not large enough. In other words, a better solution would have been a plan closer to the size of President Obama’s, which would have entailed moving even farther from the Conservatives’ irresponsible position.

Why did the Conservative argument fall apart? They believed that business investment, in the midst of a recession, should drive a recovery, and they were wrong. Businesses are generally quite reluctant to invest when the economy is contracting, so it is vain to wait for them to pull the economy back into growth. The disincentives to invest, especially given the collapse of many private financial institutions, would not have been significantly altered by the change in government borrowing. Businesses make investment plans for the long-term, and they cannot possibly make long-term plans in the midst of a recession the length and severity of which they cannot predict with accuracy. It is uncertainty that is the enemy of business investment during a recession, not government borrowing. Only a government with solid credit, such as the UK government enjoyed throughout the recession, can have the security to take action to stimulate demand through public spending and tax cuts.

The challenge facing all parties now is how to reduce the deficit without endangering the recovery. Labour and the Liberal Democrats have maintained that the recovery is too fragile at 0.3% growth to cut spending and reduce demand from the public sector now. The Conservatives argue that high government borrowing will drive up interest rates and ruin financial confidence in Britain, thus reducing economic growth. In fact, the private sector still shrank in the fourth quarter of 2009, and it was the public sector that brought the economy back into growth. If we cut the public sector now, we cannot be sure that the private sector will recover sufficiently to maintain a healthy recovery. If the Conservatives are willing to take that gamble, they must realise that it will only aggravate the current climate of uncertainty that is holding back private sector investment. The Chancellor of the Exchequer has made clear his intention to halve the deficit over four years and to avoid a contraction of public spending that might risk another quarter of negative growth. Labour have decided not to risk the recovery and have provided the clear goals for future deficit reduction that businesses and consumers need. The Conservatives have done no such thing. The government’s strategy has already borne some fruit, with the forecast for borrowing in 2010 being reduced by £11 billion, a more substantial reduction in the deficit than any single plan the Opposition have announced.

The three main parties have all acknowledged the need for major spending cuts in the coming years. They differ over where and how much to cut, and where to raise extra revenue. On tax, Labour have implemented a tax on bankers’ bonuses, and announced plans to institute a new 50p tax rate, put up the National Insurance contribution, and freeze Inheritance Tax thresholds to raise revenue. Additional revenue will be necessary once the recovery is secure to reduce the deficit in 2011 and avoid crowding out private investment. Business investment will only resume, however, once the private sector has confidence that the economy will continue to grow and profits to rise. The Conservative policies on tax, for all their arguments that the deficit will undermine growth, will reduce public revenue and obstruct efforts to reduce the deficit. They have promised to cut Inheritance Tax, taking money away from deficit reduction and public services and putting them into the hands of the social elites. They have promised to scrap most of the National Insurance rise, which again would reduce public revenue and hamper efforts to control the fiscal gap. Osborne claims his convenient announcement is fair, but what he fails to mention is that this policy, combined with the pay freeze for public sector employees earning above £18,000, means that the cost of reducing the deficit will not be distributed across the economy, but will be concentrated on public sector employees. The Labour Party has decided to spread the cost fairly, planning a rise in National Insurance and a limit of 1% on public sector pay rises: both of these plans will make a substantial difference to the public deficit.

The Labour government under Gordon Brown has not been perfect. Yet, the Prime Minister and his cabinet have shown that they understand the measures necessary both to combat the recession and to lessen its impact on unemployment. They have also demonstrated that they appreciate that growth is essential to the recovery of business confidence and private investment, and that serious measures need to be taken to confront the deficit. Not only have the Conservatives shown that they did not grasp the origins or nature of the recession. Even today, they do not grasp the danger of cutting public spending: it was the public sector which returned the economy to growth. As Election Day approaches, the Tories have lost their nerve and caved to right-wing calls for unaffordable tax cuts at a time when all parties must face the reality of economic circumstances.