30 Jun 2010 12:41:05
Speaking of spending cuts
Not only are British spending cuts picayune, but Britain would ultimately be better off if the cuts had been bigger.
The British media is having a field day bewailing the ‘most savage’ spending cuts since WWII. As usual, media sound bites distort the facts. The number of pounds spent by Westminster has not fallen in any year in the past century – excepting the aftermaths of the two world wars. As my colleague Brian Reading has already pointed out, the current budget doesn’t break that record. Spending will rise every year as usual, albeit marginally slower than inflation, so real government spending (if there is such a thing) will fall by a cumulative 3% over six years. Reductions of 0.5% a year does not fit my definition of savage spending cuts. By comparison, real government spending fell by 1% a year in 1954-55, by 2% in 1969 and by 4% a year in 1976-77. The IMF surveillance clearly assisted in cutting spending and the current budget is a picayune effort by comparison.
The current spending cuts are savage only in relation to the unrealistic expectations of how much government spending would rise. Whitehall spent 36.4% of GDP in 1999-2000 and 47.5% of GDP in 2009-10. Revenues were a similar proportion of GDP in both fiscal years, so borrowing, not tax increases, funded this massive transfer of 11.1% of GDP from the private to the public sector – and generated expectations of a cornucopia of funds effortlessly flowing into government coffers to satisfy everyone’s ever more unrealistic wish lists. Reality is very different. Borrowing to transfer 11% of GDP from the private to the public sector every decade can’t go on forever as the private sector would then disappear in the 2050s. The budget would be receiving a far better reception if the coalition had compared its proposed to current levels of spending rather than to the unrealistic expectations a decade of big transfers from the private to the public sector had generated. Moreover, those transfers were counterproductive. A wealth of studies show countries with small governments grow faster than countries with big governments and that shifting resources to the government slows growth while shifting resources to the private sector increases growth.
The rapidly rising share of resources funnelled into government explains the disappointing UK growth in recent years. By contrast, the dramatic improvements in national well being from cutting government spending in Ireland, New Zealand, Estonia, Latvia and Russia prove many, perhaps most, government programs are counterproductive. For example, Ireland slashed govern¬ment spending from 52% of GDP in 1986 to 32% in 2000 and transformed Ireland from “the sick man of Europe” to the “Celtic Tiger.” Research by Ludger Schuknecht and Vito Tanzi for the European Central Bank found expenditure reform in 22 industrialized countries coincided with rising fiscal and economic indicators and, more importantly, rising human development and institutional indicators. The percentage of working age people in jobs rose whereas it fell in non-reformers. Moreover, cutting spending helped the poorest as faster growth and targeted spending more than offset the minor effects on income distribution. Cutting spending from the current bloated levels will not only benefit the public, it is absolutely necessary if Britain is to meet the commitment it has just made to G20.
The G20 meeting last weekend agreed that governments would halve their deficits by 2013 and stabilize or reduce government debt to GDP ratios by 2016. The agreement included a review of budgets (alas, not mandatory) which could help governments sell difficult choices – as the IMF did for the UK in the 1970s. The UK is one of the nations needing to adjust its budget most to meet the G20 criteria. The June budget assumes average nominal growth of 5.1% a year, far above the 4% the UK eked out in the past decade – which featured the biggest credit bubble in history. Even so, the budget would meet the criteria only if the 2013 date refers to calendar years, and not fiscal years. The credit bubble bursting makes the assumed big rise in the rate growth in the next several years very unlikely. Lower growth will hold revenues below the budget estimates, so the deficits will be higher, leaving the UK sadly derailed from the track needed to meet its commitments to G20.
Unfortunately, G20 failed to note that the only way to reduce deficits without choking off the recovery is to cut spending, thereby transferring resources to the private sector. In fact, cutting unproductive government spending – thereby releasing resources to the more efficient private sector – is the only way out of the current morass without going through a depression. The runes are not favourable. For example, the coalition regrettably wasted a lot of political capital by talking tough on cutting spending and not delivering. Britain would have a brighter future if the budget had not overestimated growth and had contained spending cuts worthy of the epithet ‘savage.’
Leigh.skene@lombardstreetresearch.com
The views expressed in these articles are those of the writer. They may not necessarily be those of Lombard Street Research Ltd (LSR) and other LSR economists may from time to time hold different views
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