Vicky Pryce: The Chancellor doesn't need a Plan B

In my view there would be no justification for trying to find new cuts or tax increases. Why? It would be politically difficult, and unwise from an economic perspective
Click to follow
The Independent Online

Does the Comprehensive Spending Review lay the groundwork for a better future for Britain? It is certainly a fiscal plan to calm the markets and a statement of direction for government policy, and it represents the most politically significant set of decisions that this Coalition Government will take.

The review has a particular importance also because it appears so early in the life of this Government. Neither the Thatcher Government of 1979 nor the New Labour Government of 1997 attempted something of this scale and ambition so early in their parliamentary terms. In many ways the timing is opportune, brought about by the enormity of the task: tackling the deficit to retain the UK's creditworthiness and to prevent the cost of debt service rocketing as elsewhere in Europe. What is significant is the decision to go further than market expectations by planning to halve the deficit as a percentage of GDP in two years and practically eliminating it by 2014/15. It is undoubtedly a gamble as the impact on voters may determine the Coalition's fate at the next election.

But, containing the key features of the new Government's economic philosophy, it is also framed around the radical desire to reduce (or simplify) the state's intervention in markets and place greater trust, responsibility and – in some cases – risk on to businesses and individuals. Rolling back the state is of course, ideologically charged, but reducing unnecessary regulatory burdens on businesses, such as abolishing quangos and the burdensome performance regime for councils with a myriad of inspections and targets is to be welcomed.

The question is whether the Big Society, with its expectation of greater involvement by citizens collectively and individually is helped or impeded by the proposed cuts. Transferring power and responsibility to charities, localities, communities and individuals should theoretically target public services to areas of greatest need. But will organisations and people who have seen the money in their pockets reduced have the same motivation to get involved?

What is not in doubt is that the cuts will have a powerful effect on the UK economy in both the short and long term. The principal concern in the short term is whether the reductions in government expenditure could stifle the recovery or indeed, as in Ireland, push the economy back into recession.

The Chancellor has already estimated that his spending plans could reduce public-sector employment by 490,000 over four years. Of course these cuts won't happen overnight but, clearly, the hope is that many of those forced to leave the public sector or who cannot find employment because vacancies are no longer being filled will find jobs elsewhere. There are good reasons to hope that this will be the case. Even at a time of public-sector cuts, the private sector has been creating hundreds of thousands of new jobs.

But many of these positions are part-time and lower paid. Moreover, new private-sector jobs are not necessarily going to emerge evenly. There are regions and cities, particularly in the North of England whose economies are heavily dependent on public-sector employment. The expected cutbacks will hit them hard. Add to this the pay freezes and the increased pension contributions for those still employed in the public sector and the planned reductions in welfare and other benefits and it is easy to envisage a scenario where people have less to spend overall so demand and output in various parts of the country begins to suffer disproportionately.

Transferring responsibility to the private sector to sustain jobs and growth may sound OK in print but is less easy to achieve in practice, particularly given the reliance of so much of the private sector on the public sector purchasing their goods and services – something which we will see a lot less of in the future as the spending cuts bite. And this will be acutely felt in the area of capital spending where the private sector works very much in partnership with the public sector.

It is welcome that some more money has been found for capital projects than had been assumed at the time of the emergency Budget in June. It reflects well on the work done by economists across Whitehall through the summer that areas such as science have been preserved, at least in cash terms. But capital spending is still forecast to decline by 29 per cent over four years – which is by any calculation a massive cut.

The spending cuts therefore, viewed in isolation, can only be seen as generating a downward drag for the economy. And yet there are signs that the private sector is stepping in to some extent. Even if the pace of recovery we have recently seen has slowed I remain relatively sanguine. Why? Comparisons with Ireland (or my native Greece), both struggling to balance their books under pressure from the markets, are not really relevant. Not being part of the eurozone, we set our own monetary policy and indirectly our own exchange rate. Domestically, given that credit- rating agencies seem relaxed about the UK retaining its triple A rating, monetary policy should remain accommodating. A longish period of low interest rates will be good for companies needing to raise money and should keep sterling competitive. If growth in key overseas markets is maintained then I see no reason why the UK should not enjoy overall growth of some 2 per cent per annum on average over the CSR period. But the balance will have moved away from domestic demand in the short term. Managing to rebuild the economy on a sustainable basis on the back of exports and investment had been a major preoccupation of the Department for Business – my former department – and I am sure it will remain a priority for Vince Cable, the Secretary of State.

But what if plans go awry and the deficit remains higher than the plans suggest due to lower growth. Does there need to be a plan B? I don't think so. In my view there would be no justification for looking at things again and trying to find new cuts or tax increases. Why? First it would be politically difficult to achieve. And second, it would be unwise from an economic perspective. If revenues are lower because of weaker growth, cutting back further would just exacerbate the problem. Provided that the causes are clear, there is no reason why markets should punish an economy which has considerable levers – monetary policy and exchange rates – to get growth to move up again.

However, if the Government meets its fiscal objectives, now even faster than expected at the time of the Budget, public spending as a percentage of GDP is still forecast to be about 40 per cent cent in 2014/15, at the same level as 2006/07, late era Gordon Brown, but with debt much higher in relation to GDP, to a considerable extent because of the extra burden of having to step in and fund the rescue of the banks in the UK. This is a sobering reminder of the scale of problem that the Government inherited and one that will be remembered in the coming years as voters, businesses and politicians face its consequences.

The writer is senior managing director at FTI Consulting. She was director general, economics at the Department for Business (BIS) and joint head of the Government Economic Service

Comments