Why austerity won’t work

2 06 2010

Before we all put on the hair shirt and make a virtue of cutting public services the question has to be asked, will it work? Will  cutting public spending help the UK economy to revive? Is austerity necessary to keep the creditors, in this case those who lend money to the UK government,  from the door? Or is there something else going on here?

To understand what is at issue here it is first of all necessary to separate out the question of government borrowing from the problems facing the rest of the economy. The current obsession with the government deficit is because the overall amount that the government has to borrow to finance its operations has grown as a proportion of the economy over the past two years. This is due to a widening of the public spending deficit, that is the gap between what the government raises in tax and what it spends.

The main reason there is a higher deficit is that the recession led to a drop in government revenue from tax. As the recession hit, less people paid income tax as they were unemployed or took pay cuts and companies were paying less tax on lower profits. So the immediate question is, now that the economy is coming out of recession why not wait until the public spending deficit narrows again? And why does public spending have to be cut instead of more borrowing to finance the gap until income balances expenditure again?

The answer to the last question is that it does not. There is no reason why the current level of the deficit is any more or less sustainable than a higher or lower figure. In the abstract there is no level of government debt which is unsustainable. In fact Japan for example has had a much higher ratio of government debt for many years than the UK economy has now without it leading to any kind of crisis. People only fear lending money if they do not think they will get it back. The doubts over the UK economy are whether it can grow fast enough to repay the debt.

The fear is that money markets will stop lending to the UK or raise interest rates on their loans to a point where they become unsustainable. But even this fear has to be tempered by the fact that the average length of loans to the UK government is 13 years. This means that only around 7% of the loans have to be rolled over each year and thus being open to hikes on interest rates. There is therefore no immediate danger of the UK government being unable to finance public spending at its current level, even if that means having to pay a higher rate of interest on a small portion of the debt.

So why the obsession with cutting the deficit? Given that the problem was created in the first place by a fall in economic output, would it not be better to focus instead on how to grow the economy back to the point where current public spending is sustainable again? This is where the real debate should be, and where the real problems lie.

Some people argue that public spending is so high that it ‘crowds out ‘ investment in the private sector. In other words that taxes taken from the private sector and spent by the government prevent real investment taking place. There are two problems with this argument.

The first is that there is no shortage on money in the private sector which could be used for investment. The UK’s private sector is swimming in money. Nor is there a shortage of labour, the other necessity for economic growth to take place. Chris Dillow makes the point that adding together all those who could be available for work the real number of unemployed in the UK  is closer to 6 million, and that does not include those who are on incapacity benefit mainly because they get more money. So if there is no shortage of labour and no shortage of capital why can there not be faster growth? This is a subject which we have looked at in detail in previous articles . But suffice it to say that the reasons have almost nothing to do with too much spending in the public sector.

The second problem is that there is a strong case to be made that, as James Heartfield has pointed out, such is the intertwined nature of the private and public sectors in the UK, that lower public spending is likely to impact negatively on the private sector rather than positively. Around £80 billion of government spending goes straight back out to the private sector in the form of government contracts. In addition, the state supports private industry in many ways, through transport, communications, training, education, health and even direct subsidies. In fact, the first round of public spending cuts last week fell heaviest on some of the schemes that Labour had brought in to help promising parts of the private sector.

In the absence of belief in, or any plan for, faster economic growth the focus inevitably turns towards saving. When George Osborne talks about retaining the confidence of those who lend money to the UK he means he shares their lack of confidence in his ability to grow the economy and therefore has to cut consumption instead. But let us not believe that cutting consumption is the only way forward. It is only so if you have no plan to increase production.

About these ads

Actions

Information

One response

9 06 2010
What cowboy put this fiscal deficit in? « UK After The Recession

[...] is also the case that the state is now so large and so intertwined with private business that many companies depend on government contracts. The IT business in the UK, for example, has [...]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s




Follow

Get every new post delivered to your Inbox.

%d bloggers like this: