By Michael Baxter 20 Oct 2010 [0 Comments | 378 views]
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And the most eagerly awaited announcement from a chancellor in years was finally revealed today. The cuts are deep of course, £83bn worth in all, with £7bn being knocked off welfare payments and 490,000 public sector jobs to go. But George Osborne’s strategy all hinges on the private sector filling the vacuum left by the spending cuts. The big question is, will it work like that?
Osborne’s cuts include: an average cut in department budgets of 19 per cent of expenditure; a 4 per cent drop in police funding each year; and for local government, cuts will account for an almost 30 per cent drop in spending over the course of the parliament. The Home Office, Justice Department and Foreign Office will all suffer cuts of around 24 per cent. It also needs to be borne in mind that the job losses won’t be restricted to the 490,000 the chancellor referred to. There will be a corresponding cut in jobs within the private sector. Indeed, job losses suffered by the private companies could exceed the total number seen in the public sector. On the other hand, most of the cuts will be set over the course of four years. So while one might say it is foolhardy to enforce job cuts so soon after such a deep recession, most of the cuts won’t set in until, at least in theory, the economy is well on the road to recovery. Also, bear in mind that even if a million jobs are lost over the next four years as a result of this review, the private sector is easily capable of putting that many jobs back on. In fact, for reassuring markets, talk is as important as action. The chancellor has talked the talk of a drastic cost cutter, which should reassure markets and the business leaders who penned that letter to the Telegraph this week. But the fact that much of the impact of his review won’t set in until that period when most forecasters are predicting robust growth, is perhaps a truth which is far too inconvenient for most headline writers.
But we repeat the question from above: will his strategy work and the private sector take up where the public sector leaves off?
On the face of it the answer is obvious. We are in debt, and as business leaders said in their recent letter to the Telegraph: “Everyone knows that when you have a debt problem, delaying the necessary action will make it worse not better.”
Against that, when you are looking at the macro economy, things are different. If the government cuts back, job losses will follow, aggregate demand will fall, and we risk seeing a nasty downward spiral of falling demand leading to more job losses, leading to less growth, lower tax receipts, more benefit payments, and rising, not falling government debt.
The matter is compounded by the state of the UK’s consumer. According to the National Institute of Economic and Social Research, household disposable income is set to fall by 0.8 per cent this year and by 0.6 per cent next.
And so that’s the obvious risk.
Osborne’s gamble is that the private sector will move into the vacuum created by the government spending cuts, and create jobs faster than the public sector creates them.
Recently, the ITEM Club from Ernst & Young forecast that exports and investment will expand rapidly over the next few years, propelling the economy forward. See: Spending review boost: Businesses to take up slack as government cuts spending, says ITEM Club
For their part, business leaders claim that they have been holding back on spending, fearing that the huge levels of government debt will lead to nasty problems in the years ahead. So they are saying corporate Britain has been saving for the rainy day. They then say that, by contrast, if the government can slash debt, they will feel more comfortable about spending. In effect, business leaders are saying that government spending has crowded out the private sector.
On the other hand, corporate Britain, and indeed corporate America, has been saving for years. In the US, corporate profits as a percentage of GDP hit an all-time high just before the recession.
It is all very well saying that government spending has held back the private sector, but it could be argued that it was the high levels of corporate profits and low wage inflation during the noughties that created the economic crisis in the first place. Recall, during the mid noughties, household discretionary disposable income actually fell, and then rose during the recession. See: What kind of recession was that? – households were no worse off and: You have never had it so good – well actually you have So, this argument would suggest that the reason why government borrowing is now so high, is because corporate saving fell too low in the first place, and not the other way round.
But the big problem may relate to quantitative easing (QE). In the absence of government spending, monetary policy seems to be the only form of economic stimulus available. But so far, QE seems to have achieved very little.
It seems the only way the Bank of England can use QE to stimulate investment, and get banks to provide capital to business, is if the bank directly buys bonds drawn on banks which are more disposed to lend to business, ideally in the form of venture capital.
But, if the Bank of England did that, then it would be debatable whether QE has mutated into a form of fiscal policy, and therein lies the problem.
Even so, the big question remains: is George right? So we repeat: will George’s strategy work and will the private sector take up where the public sector leaves off?
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