Careful, chancellor: there is good austerity and bad austerity (City AM)

Planned cuts to government expenditure pale in comparison to its huge expansion under New Labour, writes City AM editor Allister Heath.

To read the full article, visit the City AM website.

“THERE are many reasons why the economy is underperforming. One of them is that George Osborne has been dishing out the wrong kind of austerity. Don’t get me wrong: the chancellor is right to want to cut the deficit by 9.2 per cent of GDP. But the speed and composition of the plans are wrong.

The 8-year timetable is too long; and far too much of the burden in the first couple of years has been placed on tax hikes, and far too little on reduced government consumption. As the Centre for Policy Studies reminds us, planned cuts to government expenditure over this Parliament (about 4 per cent in real terms) pale in comparison to the huge expansion (61 per cent in real terms) of the state under Labour (albeit over a longer period).

We keep hearing that the chancellor’s mix is 80 per cent–20 per cent in favour of spending cuts, and that this is what international organisations believe to be the optimal mix. Even if that were true – our problem is one of excessive spending, not one of excessively low tax, so I would have focused exclusively on tackling our bloated state – this omits a crucial caveat. The evidence is that it is government current spending (including wages or benefits) not government capex (such as roads) that should be cut to maximise growth.

The bigger issue is that Osborne hasn’t actually delivered 80-20. The Institute for Fiscal Studies reveals that more than half of the fiscal consolidation in 2011-12 and a third in 2012-13 came from tax hikes. The chancellor’s claim is right over time, but misleading in the short-term. It is also clear that an unhealthily large chunk of the consolidation by 2013-14 is still accounted for by tax hikes and cuts to capex. It is only by 2015-16 that the share of tax hikes in the cumulative reduction of the deficit falls to a fifth (19 per cent). By 2017-18, it is down to 15 per cent, with the relative importance of capex cuts also falling.

Given that tax hikes damage growth, as does cutting capex (unless it is replaced by private investment), the fact that both of these have been front-ended in this way are one reason – there are of course many others – why the UK’s performance is so poor. GDP is now forecast by the Office for Budget Responsibility to grow by 4.3 per cent over this Parliament, compared to the 6.7 per cent forecast in March and the 11.2 per cent originally forecast in the Emergency Budget of June 2010. It is excellent news that Osborne will be seeking a healthier cuts to tax hikes balance after the next election – but by then it may well be too late.

There are plenty of areas in which extra savings could be found. Why is the taxpayer going to fork out £50m to give Old Street’s Silicon Roundabout a facelift? Or take public sector employment: the ONS says that the public sector headcount is down 628,000 from 6.292m in the second quarter of 2010 to 5.664m in the second quarter of this year, a drop of 10 per cent (or 9.5 per cent on a full time equivalent basis). There was a 6.5 per cent fall between the second quarter of 2011 and the second quarter of 2012 alone (5.9 per cent full time equivalents).

Yet total pay in the public sector rose from £168.027bn in 2010-11 to £171.217bn in 2011-12, a 1.9 per cent increase. How can this be possible? Some of it might be accounted for by payoffs but it does seem to suggest an explosion in the unit cost of labour in the public sector.

Last but not least, there must be more scope for welfare reform: in 2010-11, 53.4 per cent of households received more from the state than they paid in taxes, up from 43.8 per cent in 2000-01. We need austerity, but it needs to be of the right kind.”

To read the full article, visit the City AM website.

Date Added: Friday 7th December 2012