The cuts imperil our economy—for Tory gainby Anatole Kaletsky / April 20, 2011 / Leave a comment
Published in May 2011 issue of Prospect Magazine
The tax increases and spending cuts that began in earnest in April will remove two percentage points of GDP in spending power—roughly equivalent to the total growth of GDP in 2010—from the economy in each of the next four years. This will be the biggest fiscal consolidation attempted in postwar Britain. The cumulative saving will be, according to the IMF, the most extreme belt-tightening attempted by any OECD country apart from Iceland and Ireland. Will the coalition succeed in this unprecedented experiment?
Economics and politics suggest very different answers. On economics, the debate has been about whether the reforms will improve business confidence, competitiveness and work incentives. But such “supply-side” concerns will become almost irrelevant if the squeeze on personal incomes causes a sharp fall in demand. Even if some of the controversial cuts—such as reductions in the disability living allowance—prove popular with voters, they will take money directly out of consumer’s pockets. Most beneficiaries of public spending have no substantial savings and will cut back immediately on consumption when their incomes fall.
Thus, the key financial question for the rest of the parliament will be how the money withdrawn from the economy by the government can be replaced by new private spending. Consumers and private businesses, the Office for Budget Responsibility somewhat hopefully assumes, will be so inspired by the government’s prudent behaviour that they will be emboldened to do the opposite: increase their borrowing and eat into savings. Sadly, there is no reason to expect such an upsurge of confidence among people who see their taxes rising, their real wages falling, their benefits and pensions cut and their public sector jobs disappearing. In fact, with the cuts approaching, consumer confidence has fallen back to the almost unprecedented depths plumbed at the worst point of the banking crisis, in the winter of 2008-09.
Apart from faith a…