The middle of the line

The major parties are competing in earnest to see who can cut most from public spending. The Lib Dems have performed a massive volte-face and where a few years ago they positioned themselves as to the left of New Labour on some things, they now have a leadership who promise ‘savage cuts’. The Tories are trying very hard to conceal their glee at the prospect of being able to slash budgets, particularly where their favourite bugbears are concerned – benefits, social care, etc. Labour are also talking about savings that can be made.

Now, of course, there is always a good case for trimming fat in public services. Large organisations tend to ossify over time, leading to waste. Poor management (the British disease, and which afflicts the private sector too) needs to be challenged. Providers should be kept on their toes.

However, the media and a lot of politicians seem to assume that cuts (and drastic ones at that) are necessary. The right wing are selling the line that the country is ‘bankrupt’, or almost there, and that the sooner the knife is wielded, the better.

I disagree. What’s more quite a few others, who are more expert in economics than I am, disagree. Duncan Weldon, for example, points out in a recent post on George Osborne’s speech that demanding lower spending across the board appeared to make the 1930s depression far worse and last far longer.

The figure most often used is that we are facing a budget deficit of £175bn. Sure, that’s a lot of money for the government to be spending over its income. But this deficit is made up of four factors:

1) Because there’s a recession, tax intake is lower.

2) Because there’s a recession, spending on things like benefits is higher

3) In order to stabilise the economy, and with the hope of stimulating growth, the government has spent billions on on-off measures and cut some taxes temporarily.

4) There is an underlying deficit

(1) – (3) will all end soon. With a return to growth, tax revenues will increase. As that growth beds in, the stimulus spending can be reined back. When that growth starts to create new jobs, spending pressures will decrease.

What’s more, a large part of the extra spending was to buy bits of failing banks. The shares were priced very low when bought (because bank stocks were understandably pretty undesirable in late 2008, especially those of banks liable to go under), but of course a recovery – and particularly even a moderate one for banking – will see the value of those shares rise. Not only will loans be repaid, but the Government could end up making a pretty good profit.

Additionally, the problem with cutting public spending while the private sector has not fully recovered is that the two ‘sides’ are not unrelated. Public spending largely means people in jobs, who end up with some money to spend. They will use that money to buy stuff, from the private sector largely. Cut job, or freeze wages, and discretionary spending goes down. Not a problem if the private sector is healthy and has solid growth. Potentially disastrous if the private sector is at the bottom of a recessionary curve and any growth is weak.

Keynes is still relevant today. You borrow to spend in a recession, to limit and mitigate the effects. You don’t start trying to pay that back until you are in growth. The fact that during the last period of growth we did not draw down much of the debt (although it was about the same as a proportion of GDP in 2007 as it was in 1997) does not alter the principle – growth is the best way to curb public debt, but cuts in spending can negatively affect growth.