If David Cameron were in any doubt about the likely public reaction to his reshuffle, it was surely dispelled in the Olympic stadium on Monday. When a grinning George Osborne stepped up to present medals to Paralympic Games winners, the chancellor was met with an eruption of booing – while an apparently rehabilitated Gordon Brown was widely cheered.

The message of Osborne's humiliation couldn't have been clearer. The switching around of Hunts and Graylings would count for nothing. The minister the public most want to see the back of is the man who has driven the economy into the first full-blown double-dip recession since the 1970s, while cutting taxes for the rich, and whose benefits cuts have tipped disabled claimants into suicide as Britain embraces the Paralympians.

But as had been signalled from the start, there would be no change to the top cabinet jobs, at the Treasury in particular. Cameron and Osborne are joined at the hip politically. If the prime minister were to sack the chancellor, as half the country wanted, it would have been an admission that his government's entire economic policy and the centrepiece of the coalition with the Liberal Democrats had been an abject failure.

Which by any rational reckoning, it has been. Cameron and Osborne are presiding over a slump which has now lasted longer than Britain's depression in the 1930s. Having inherited a growing economy on the back of Labour's post-crash stimulus, their cuts and tax rises have choked off recovery. The economy is now smaller than when the coalition came to power and still 4.3% below its pre-crash 2008 peak.

The idea was to cut spending and borrowing, and slash the deficit. The private sector would then ride to the rescue with investment and growth to fill the gap left by a smaller state. Nothing of the kind has happened – any more than it has anywhere else such austerity packages have been driven through since the crash.

Osborne has failed miserably, even on his own terms. Public spending is rising as the costs of recession outstrip cuts, borrowing and the deficit are both rising because the economy is shrinking and tax receipts falling. Instead of investing to take up the public sector slack, corporations are sitting on cash mountains and the banks are still failing to lend four years after they were bailed (or part-bought) out by the state.

The result is falling living standards, insecurity, joblessness and underemployment, with a wave of new layoffs and insolvencies expected as cuts and tax rises bite deeper. Naturally ministers blame the eurozone crisis, but Britain's downturn started earlier, and exports to Europe only recently started to fall.

No wonder business support for the coalition's austerity is cracking, and Tories and Lib Dems have fallen out among themselves and with each other. So Cameron and Osborne have now come up with a "plan for growth", as good as admitting their strategy isn't working.

The package they've lined up certainly sounds like some of the things their critics have been demanding: including government guarantees for £40bn of investment in infrastructure and £10bn in housing, plus a state-backed bank to boost small business lending (as well as a loosening of planning regulations, which they haven't).

But it's nothing of the sort. From what we know, there will be no "guarantee" of £50bn investment, but underwritten loan sweeteners for private developers, with no return to the public purse. And the small business bank isn't going to be a bank in the normal sense at all (let alone a public investment bank) – more a new badge on existing government schemes.

These are sops, not game-changers. The Tory right, meanwhile, has a growth plan of its own: more business and personal tax cuts, still deeper cuts in public spending and employment deregulation to make your eyes water. Cameron's former leadership rival David Davis calls it "shock therapy" – and wherever that's been carried out, from Chile to eastern Europe, it's been a disaster: all shock and no therapy.

In fact, as Cambridge economist Ha-Joon Chang argues, among others, the evidence of the past half-century or more shows that deregulation, tax cuts and austerity programmes have never delivered the results claimed for them (though they have succeeded in shifting wealth and income from the poor to the rich) – and are even less likely to do so in the aftermath of the crisis of the neoliberal model that spawned them.

After yesterday's reshuffle shifted the government rightwards, pressure to move further in Davis's direction seems likely to grow. But so does the demand for the third option. Which is the one that could actually offer a route out of economic stagnation, rising unemployment, falling incomes and welfare cuts: large-scale public investment in housing, education, transport and cutting-edge technology, backed by a boost to demand, and financed through fully nationalised banks as well as borrowing for a return, at the lowest rates for 300 years.

Fearful of charges of profligacy, Labour's front bench has positioned itself somewhere between a public investment and growth package and the coalition's austerity, even as Vince Cable and his Lib Dem allies have argued for bank nationalisation and a crash housing programme. The clearest case for state-led expansion will be made at next week's Trades Union Congress. But as the crisis deepens, the battle between alternative routes out of the crisis can only become sharper – in Britain and across Europe.

Twitter: @SeumasMilne