What impacts are spending cuts having for growth?
It’s no secret that the recovery is on the rocks. Growth of 0.1 per cent over nine months and the highest unemployment levels in 17 years is nothing to shout home about, and with global demand slowing sharply and the crisis in the Eurozone still unresolved the future direction of the UK economy is looking increasingly uncertain. With the UK recovery still one of the weakest in the developed world (as well as being the slowest on record) we are still only 2.8 percentage points off our recessionary slump.
Given this challenging outlook it is perhaps no surprise that debate about the causes of our economic stagnation is raging. While the Government maintains that the Eurozone is to blame the evidence is fairly convincing that our problems significantly pre-date its difficulties. But the argument doesn’t stop there – the second question is whether the Government’s spending cuts can legitimately be blamed for our current mess.
My answer is that they are at least part of the problem. It would of course be absolutely wrong to place all of the blame for our deteriorating economic circumstances on the Government’s programme of spending reductions. High inflation, driven not just by rising VAT but also by high import prices (the result a rise in global commodity prices, a weak pound and possibly the long-run loss of domestic capacity to make the products we are still importing from overseas) has played its part. And ongoing problems with access to credit are also undoubtedly causing difficulties. But it would also be misleading to deny that spending reductions are themselves limiting growth and hindering our capacity to boost demand in response to greater than anticipated economic weakness.
What is the evidence that backs up this case? Firstly, the OBR forecast recognised that cuts would limit output (for example, the OBR’s June 2010 Budget forecast assumed that the increase in the standard rate of VAT from 17.5 per cent to 20 per cent would reduce the level of real GDP in 2011/12 by around 0.3 per cent). This is unsurprising – even the IMF recognise that fiscal contractions increase unemployment and that as a result of global austerity and the financial crisis ‘fiscal consolidation is now likely to be more contractionary (that is, to reduce short-run income more) than was the case in past episodes.’
But it also appears that the cuts are having impacts beyond those the OBR’s March forecast anticipated. The economy has performed more poorly than they foresaw, yes against inflation but also against public sector job losses (111,000 lost in the first quarter against an OBR projected 20,000 over the entire year, leading CIPD to call for a moratorium in public sector job cuts), claimant unemployment (already 37,000 (2.4 per cent) above the OBR forecast for Q3) and earnings (forecast to be 2 per cent in Q3 but currently running at 1.8). Over the last ten months independent economists have also become far less positive about the role that domestic demand will have for growth, with it now forecast to subtract 0.4 per cent from the economy – in contrast the OBR forecast anticipated private consumption and business investment growing throughout this year.
So it is perfectly feasible that the OBR could have underestimated the impact of spending reductions on the economy and that cuts are leading to falls in consumer and business confidence, reductions in real household incomes (as the public sector wage freeze, tax credit cuts, benefit reductions, higher unemployment and the VAT increase bite) and levels of job loss that were beyond expectations at the start of the Government’s austerity drive.
But even if you don’t accept that poorer than expected economic performance is anything to do with spending reductions, it is beyond doubt that sticking to their plan to reduce the deficit over the course of one parliament (and to have debt as a proportion of GDP falling by 2015/16) is hampering the Government’s ability to respond to it. As Samuel Brittan has recently written in the FT:
These [austerity] programmes are likely to fail in their own budget-balancing terms because of their kickback effects on growth…What the economy is short of is demand
The growing recognition of our demand problem has led many across the political specturm to call variously for the austerity programme to be slowed (The Economist), for immediate stimulus measures to be taken (the ITEM club) or for the OBR to be given responsibility for determining the pace of deficit reduction based on the economy’s strength (IPPR). And ideas for what the stimulus could include are also many – for the Government to support direct lending from the Bank of England to small businesses (George Magnus), a two year introduction of 100 per cent capital allowances for manufacturers (EEF) and cutting VAT to 5 per cent in tourism and construction (FSB). Whatever your position on specific ideas the facts are that there is an increasingly broad consensus around the need for the Government’s current plans to be revised to support short-term growth and economic recovery.
Everyone hopes that the Q3 GDP figures are positive – although with the consensus of independent forecasts now that the economy will only grow by 1 per cent over the entire of 2011 they seem unlikely to be strong. But whatever the latest growth figures the facts are that they could be better if the Government changed course.
This is a human tragedy. Every month that growth remains weak unemployment will rise, wages rises will remain muted and more of our future productive capacity will be lost. Every over zealous cut leads to unnecessary job losses and reductions in vital services and support – poorer education for young people, fewer investments in regional infrastructure and less help for victims of domestic violence. Only those who truly believe that the Government really has no choice in cutting as far and as fast as it has chosen to do can possibly think that we are heading in the right direction.