George Osborne’s latest announcement on the need to reduce the public sector deficit included suggestions that departmental budgets would be cut by up to 20% by measures including abolishing planned increases in free school meals’ provision as well as cuts to pensions and welfare payments. But even this announcement was almost overshadowed by a report from the Fitch credit ratings’ agency that called for a ‘more ambitious deficit-reduction plan’ to ‘underpin market confidence’.
This is widely taken to mean that the ConDem coalition should accelerate its planned spending cuts. It was seized on by Osborne in support of his own extreme measures.This is an ugly Punch & Judy show now familiar to the ordinary population, workers and the poor in Hungary, Ireland, Germany, Greece, Spain, Portugal and elsewhere. Either an international agency or the national government will declare there is a crisis of government finances and offer no solution to it. This cry of imminent fiscal disaster is then taken up in the financial markets, the press and other media and is echoed by the ratings’ agencies. At that point either the international body or the national government will announce that the markets/ratings agencies are demanding spending cuts. It is a show where the population are repeatedly clubbed.
The ratings’ agencies themselves play a further role in this - accepting the governments’ unwillingness either to stimulate growth through investment or to use tax increases rather than spending cuts.But in the latest British case this pantomime is even more transparent than usual. As can be seen in Figure 1 below Fitch outlines its projected paths for the budget deficit depending on a 1% difference in annual GDP growth. Fitch chooses to project the deficit based on the possibility of consistently lower 1% growth over a 4-year period. But the same process would work in reverse. A 1% higher growth would reduce the projections for the deficit by same amount. In this way, at the end of the period Financial Year (FY) 2014/2015 the deficit would be just over 2% of GDP.
And this awful pantomime is continuing - with the ratings’ agencies, Fitch included, now citing the austerity measures taken in countries such as Greece, Spain and Portugal as a reason to downgrade their debt, on the logical grounds that lower tax revenues will follow and therefore meeting interest payments will become more onerous. Yet the downgrades themselves undermine government bond markets further and so the clubbing of the population is renewed.
Investment Leads To Growth
Faced with this farce it is vital to realise that government spending is both a component of GDP and a catalyst for private sector activity. In Britain the cuts programme is already having a detrimental impact on growth before they have barely begun. Building contractors are laying off workers now because of the cut in the schools' building programme. And the British Retail Consortium warns of the damage done to shops sales if the much-touted and wholly regressive rise in VAT takes place.These are practical demonstrations of the fact that these cuts will not produce a balanced budget as every cut reduces growth in both the public and private sectors and the taxes that flow from it. By contrast, for example, a small increase in higher education spending increases the employment rate for graduates - providing government with a huge return in the form of both higher income tax revenues and lower welfare payments.
Learning LessonsCameron’s recent invitation to Thatcher to tea at No.10 may have been a nod to the right wing of his party, but he should have factually quizzed here on how her deficit-reduction efforts turned out. Just like Thatcher, Cameron-Clegg will find that their cuts lead to a widening deficit.
In the Financial Year (FY) 1978/79 before Thatcher took office, and itself a year of economic turmoil, public borrowing was £8.75bn. In the next five years it was successively £8.6bn, £11.5bn, £6.0bn, £8.5bn and £10.5bn - an average £9.0bn. And that was with a bonanza from North Sea oil, which will not recur this time. Simultaneously public sector net debt rose from £98bn to £157bn over the same five year period.The present economic disaster in Ireland
Prior to the election, George Osborne repeatedly argued that Britain should follow the example of the fellow Thatcherites in the Dublin government and slash spending. Fiscal tightening on the scale of Ireland in 2009 would be equivalent, in comparative GDP terms, to £90bn in Britain. But the Tories admiration for Ireland’s 'slash and burn' has become an embarrassment as the latter now has a 14% unemployment rate despite the return of mass emigration, and the budget deficit has doubled to the highest in the European Union, at 14.3% of GDP, despite Ireland having started the recession with a budget surplus
The fake parallel to Canada
First, simultaneously with Canada's tightening, the US was undergoing a huge boom - and the US accounts for 85% of Canada’s trade. Second Canada embarked on encouraging large-scale immigration - which particularly attracted wealthy Hong Kong Chinese. No such windfall, or policy is likely for Britain this time around.Even then the Canadian case was accompanied by a 15% fall in the value of the Canadian Dollar and growth averaged just 1.7% over 5 years - and even this was entirely due to net exports as the domestic economy was in permanent recession. Because of this unemployment averaged 10.4% and government debt actually increased from 50% of GDP to 70% of GDP!
The lessons of the real world show it is impossible to see cuts as a way to prosperity and to lower debt. A genuine economic recovery is a pre-requisite for deficit-reduction. Government investment is required to spur that recovery.