The cuts are unprecedented. They may also be impossibleby Paul Johnson / June 22, 2011 / Leave a comment
Published in July 2011 issue of Prospect Magazine
The sheer ambition of the cuts may be their undoing, argues the head of the IFS. Image: altogetherfool
It might appear that a crisis in Britain’s public finances has been averted. The country’s finances for 2010-11 were better than expected. Tax rises and spending cuts should see the budget deficit largely eliminated within five years. The markets seem relaxed, and the interest rates the government pays on its borrowing remain modest. So the question arises: is George Osborne right to stick with his programme of cuts?
As ever, the answer is not straightforward—and complacency is certainly dangerous. In 2010-11 Britain had the second biggest headline deficit in 60 years: nearly 10 per cent of GDP. It was surpassed only by the record, set the previous year, when the deficit, £34bn in 2007-08, increased to just over £155bn in 2009-10. The sheer scale of the cuts needed to address this will be an unavoidable backdrop to all government policy over the term of this parliament.
So the debate is not whether, but how quickly the deficit must be tackled. The government is planning to cut spending by 6.6 per cent of national income by 2015-16. The last Labour government’s pre-election plans involved cuts of 5.4 per cent by 2016-17. The difference between these two, though perhaps useful for drawing the political dividing lines, should not be exaggerated.
But the speed of deficit reduction does matter. Faster action may stifle growth more in the short term; slower action may make lenders to Britain demand higher interest rates. In extremis, lack of credibility in the government response could trigger the sort of crises seen in Greece, Ireland and Portugal. Despite what some may claim, it is unclear whether the difference between the government’s plan and its predecessor’s is big enough to affect any of these chances substantially.
Over the short term, the prospects for growth certainly don’t look rosy. Between October 2010 and March 2011 the economy flatlined. For the March budget, the Office for Budget Responsibility (OBR) downgraded its growth forecasts for 2011 and 2012. Most forecasts are for poor economic performance over the next couple of years. Given the extent to which both public and private sectors are repairing their balance sheets, this is probably not surprising.
However, the OBR has not changed its view of the economy’s output potential for the longer-term, and has upgraded its forecasts for growth in later years. It expects the chancellor to meet his target for budget balance in 2015-16, one year ahead of schedule. Given that the OBR is the new official independent arbiter of these things, set up by the government just after the election as a fiscal watchdog, Osborne is remarkably dependent on its forecasts. If the OBR were to downgrade its predictions of growth, he would likely have to accept a delay in the balancing of the budget.
Much more worrying for the government would be a return to recession or a really significant downgrade to the OBR’s estimates of long-term growth. Were that to happen we might well need a macroeconomic “plan B.” The really tough economic judgement will be determining the point where growth, or expected growth, becomes poor enough to force the government to change tack. The tough political judgement is over what to say about this possibility. To insist that there is nothing that would force a rethink may lack credibility. To speculate about the circumstances that would lead to a change of policy might fuel uncertainty.
Even assuming the recovery progresses as expected, it will not be a “feelgood” recovery, and this brings political risk. With relatively high inflation, real earnings are set to fall. Tax rises have already hit people’s pockets—and benefit cuts have only just begun. Estimates by Institute for Fiscal Studies’ researchers suggest that real incomes will on average be no higher in 2013 than they were in 2004. Unlike previous recessions, the pain from this one will be shared across society; in contrast to that of the early 1980s, in which millions became unemployed while others prospered.
Finally, the sheer ambition of the cuts may be their undoing. Local government, the home office and the ministry of justice face real terms cuts of a quarter in the next four years. Cuts on this scale have not been attempted in modern times, let alone delivered. Even the NHS, protected from deep cuts, faces its toughest times in a generation.
We have already seen the prime minister baulking at the consequences of cuts, in his recent rethink on reduced jail terms for certain criminals. As he will no doubt know, in politics, the majority counts; and the clamour for higher spending to help through the hard times may, in time, become too loud for him and his chancellor to ignore.