Public spending cuts: ineffective, unnecessary, dangerous
Politics seems to be on a collision course with economics at the moment. With the right-wing press screaming for cuts and the polls showing a majority of voters agreeing, the main parties are now positioning themselves as cutters.
This is not democracy at its best. The arguments against any major and urgent cuts programme are extremely strong but they are now being crowded out by a debate that is shaped by the desire to win the political rather than the economic battles ahead.
I won’t go into too much detail but it seems to me there are three main arguments against cuts.
1. Cuts are ineffective; they will not reduce the deficit and may actually increase it. As I pointed out in a previous post, this was the experience of the early 1980s. Margaret Thatcher’s attempts at cuts in the early 1980s created a deep recession which seriously damaged the public finances. The deficit only began to reduce in 1985 when the economy recovered.
The reason why cuts don’t reduce deficits is clear. Spending reductions cause job losses in the public sector and job losses and financial problems in the private sector (as the state’s procurement of services and products from private companies is reduced). This increases the bill to the state for unemployment benefit and also for increased spending on health, social and police services – the demand for which always rises during periods of higher unemployment.
At the same time the money coming into the Treasury is reduced as those without jobs stop paying income tax and the companies that face difficulties pay less corporation tax. VAT receipts also drop as people and companies buy less. It’s a major double whammy for the state which only compounds the problem of higher costs and lower tax receipts which are an immediate result of any recession.
Ireland is learning this harsh lesson having now passed two austerity budgets which only seemed to have deepened their economic crisis, have done nothing to revive tax revenues and have left the credit rating agencies unimpressed.
2. Cuts are unnecessary; as long as the state can borrow at a reasonable interest rate there is no need to make cuts which could worsen the economic situation. Earlier this year, there were hysterical predictions of spiralling interest rates being demanded on future government borrowing and of investors refusing to buy gilts (bonds issued by the UK state). Neither of these things has happened. In fact, gilts are still being snapped up by investors at very reasonable interest rates and there is no sign of any major shift away from this.
The truth is that public debt is an important but far from the only factor influencing the attractiveness of gilts. Issues such as inflation risks, the performance of other assets (such as shares) relative to gilts, and the long term picture on interest rates create a complex set of interlinking factors.
But one issue which is always conveniently left out of the mix by those demanding cuts is the performance of the UK economy compared to other national economies. If the UK economy fails to pull out of recession and is left behind in the growth stakes by other advanced economies, then there could genuinely be a panic on the bond, currency and equity markets combined as investors begin to fear for both the public finances and the wider long term performance of the economy. This is why introducing major cuts in public spending and risking any recovery could bring about just the crisis that the cuts brigade claim to be averting.
3. Cuts are dangerous; a major programme of cuts risks forcing the UK back into recession and damaging our economic prospects for a generation. It doesn’t take much economic nous to recognise that sacking tens of thousands of public sector workers and reducing the amount of money the state spends in the wider economy will increase unemployment, increase bankruptcies and other financial difficulties for companies and will reduce demand and further constrain bank lending.
This is, of course, bad enough in itself. But there is a further threat. If the UK struggles on under recssionary conditions while other economies grow, we will not be able to seize global market share and we will not be able to attract new investment. The result will be a UK economy back in the doldrums for years just as it was in the 1970s and much of the 1980s – the “sick man of Europe”.
This is a much greater threat to our well-being and the future prosperity of our children and grandchildren than public debt. Asia is emerging from this recession far quicker than Europe and America. China is expected to post a stunning 8% growth soon despite the global crisis. If we take shallow economic decisions now, the UK will be left behind as the new economies rush past us in the innovation, productivity and investment stakes.
None of this is to say that we do not need to address the problems of the public finances. Having to service very large interest payments over the long term is clearly not the best use of taxpayers’ money. It reduces the state’s scope for action particularly when there is a need for public investment and if any major and unexpected spending need arises. But introducing cuts in the short-term for fear of some impending crisis on the money markets (as promoted by the Tories and others) is spurious and will leave us a weaker rather than stronger nation.