Conservative Home

« Robert Halfon MP: The Sri Lankan government must stop persecuting Tamils and acting like a rogue nation | Main | Jeremy Brier: Economic measures will not stop the Syrian regime. Only a military response will work. »

Lord Flight: Deficit financing might get a lot harder so Osborne should cut faster now

Screen shot 2012-01-10 at 11.11.54Lord Flight is a former Shadow Chief Secretary to the Treasury who is now chairman of Flight & Partners Recovery Fund.

The brutal, internal devaluation measures being forced on Greece by Germany and the EU are likely to be self-defeating. They risk a recession so deep that Greece will not be able to climb out of its debt hole. The measures will lead inevitably to a higher debt to GDP ratio in the near term. Greece has been in recession for the last 4 years; Greek GDP fell by 6.8% last year, accelerating to 7% this year. Unemployment is likely to rise to at least 25%. Similar, if not as harsh, measures will be forced on Portugal, Spain and Italy. The problem with Southern Europe is that is has become some 30% uncompetitive against super-efficient Northern Europe. As Irving Fisher pointed out in “Debt Deflation Causes of Great Depressions”, in 1933, it is very difficult, if not impossible, for a country to regain lost competitiveness in a fixed exchange rate system if it has a high debt. Countries trapped in Euro membership with substantially overvalued exchange rates and no control over monetary policy face the choice of immense and on-going economic pain if major internal devaluation is attempted, or “dignified exits” from the Euro.

It may, therefore, appear strange and inconsistent that I believe the UK should follow a programme of stricter deficit cutting. The Greek and UK contexts are, however, quite different. The UK does not have a problem of competitiveness – with its own currency the exchange rate has already fallen and can fall further if needed. By contrast with Greece, there is still massive feather-bedding in UK public spending (whereas more and more Greek citizens face unemployment, they will receive no welfare assistance once their short term unemployment benefits run out). The Duncan Smith welfare reforms are, if anything, too generous; the “cap” on welfare payments is equivalent to a taxable income of £35,000 p.a., more than the average income. Massive waste continues in UK public spending; Government spending, both directly and indirectly through Quangos, continues to finance activities with which the State should not be involved. Aside from the criticism of Professor Les Ebdon’s appointment, what on earth is the taxpayer doing financing a “new universities access watchdog” – universities are the appropriate body to manage their admissions policies, which the evidence points to them doing well.

Public sector remuneration remains significantly too high in relation to private sector remuneration. On average, public sector employees work significantly fewer hours, take significantly more sick leave and enjoy enormously better pension arrangements and better security of tenure. Reflecting this, public sector pay has, historically, been on average around 10% less than average private sector pay. But as the result of Gordon Brown’s public spending binge it is now, on average, some 10% higher than private sector pay. If reductions in public sector pay are considered a good thing in Ireland, to restore the public finances, why not in the UK? The British economy will not return to better rates of economic growth while public sector spending is at 50% of GDP and taxation is significantly too high in the private sector, squeezing it of resources. The fundamental point is that productivity in the public sector for the last decade has actually fallen – leaving the private sector not only the sole engine of economic growth, but also before any growth is achieved having to offset the negative contribution from the public sector.

Notwithstanding the political problems, there is also no economic sense in ring fencing some but not other Government department budgets. Sooner or later the NHS will need radical reform. It is worth remembering that not long ago, when Sir John Major was Prime Minister, NHS spending was of the order of £20bn p.a. – it has already risen to £110bn p.a. It is clear that it will become unaffordable in due course, if spending increases at anything like this rate. Notwithstanding the rhetoric of “cuts” in Government expenditure, it is actually planned to increase in nominal terms from £688.6bn in 2010/2011 to £736.4bn in 2015/16. In real terms the fall is only a marginal 0.9% p.a. A budget deficit of over 8% of GDP – around £120bn – is unsustainable for more than a very short period. The massive increase in public debt from 60% to 76% of GDP by 2016 lands the next generation with both far larger debt servicing costs and massive debt to repay. As the recent CPS Point Maker Paper, “How to Cut Government Spending – Lessons from Canada”, points out, since addressing its excessive deficits, Canada has had the highest growth rates of the developed economies.

Its two key policies were achieving smaller Government and smarter Government. Correctly, it relied far more on spending cuts than on tax increases. Mistakenly, most of the UK measures to date have comprised tax increases, not surprisingly, slowing economic growth. Moreover, while the initial UK plan to eliminate the structural deficit by the end of the Parliament, though not exactly bold – had a logic. In response to lower growth forecasts in the 2011 Autumn Statement, the plan has changed, subtly, to sticking to the initial spending plans but continuing to increase debt and deficits into the next Parliament. It is fortunate that over the last year spending has risen less than forecast – by 1.6% versus 3.1%; but this does not change the material point that if we want to return to better levels of economic growth sooner rather than later, and avoid the risk of encountering funding problems, it would be wiser to get on with larger cuts in spending now.

So far the Government has been able to fund its deficit cheaply, substantially, via the Bank of England’s massive QE programme – the Bank of England effectively buying the Gilts. There is an economic logic to matching fiscal tightening with loose monetary policies and even to the QE printing of money to keep up the money supply. This cannot, however, be done for long without risking it leading to a major burst of inflation as and when the economy recovers. Also, the Chancellor would be hugely ill-advised to assume that it will be easy to finance deficits of the size planned for another 4 or 5 years. In short, therefore, there is a powerful argument for the UK getting on with cutting public spending more aggressively, now, in order to avoid the risk of being forced into far harsher spending cuts later. Moreover, if the sort of programme pursued successfully over the last 15 years by Canada is followed, the nature and extent of larger cuts, rationalising the public sector, would be “chicken feed” in comparison to that which is now being forced on Greece, as the result of spending and debt getting out of control.


You must be logged in using Intense Debate, Wordpress, Twitter or Facebook to comment.