Hamish McRae: A savage start? Maybe, but this is just the very beginning

All European governments have been under pressure to cut their deficits but the plight of Greece gave this a new urgency

Sunday 23 October 2011 00:12

There were two reasons, one external, one domestic, why the Government had no option but to start making some cuts to public spending right away.

First, the mood across Europe has radically shifted in the past few weeks, shifted indeed since the general election. All European governments have been under pressure to cut their deficits but the plight of Greece gave this a new urgency. The weaker countries had to move fast. So Portugal and Spain have introduced emergency packages and Italy is planning cuts. But even the strongest countries are moving: France to bring in new constitutional measures to move towards a balanced budget and even Germany has just announced it will start cutting spending and will continue to do so progressively in the years ahead. The UK, with a deficit far worse than any of these countries bar Greece, could not hope to resist this tidal wave.

Second, the new government had to signal to its own civil servants that a radical change of mood would sweep through the spending departments. The taps have been wide open – open to such an extent that civil servants were voicing concerns that the previous government was not getting value for money. Now they are being snapped shut. So the government machine has a new, different and much more difficult task. It needs political leadership to guide it. It needs to know that this Government is serious; that ministers do what they say they will do; and that the Civil Service will get support when it puts forward unpalatable options.

Will these immediate cuts affect the recovery? That suggestion makes no sense. The numbers don't work. Cuts of £6bn may be a necessary start to impose discipline in public spending but they are tiny in the context of a GDP running at more than £1,396bn a year. Indeed the boost to confidence from the knowledge that the Government is getting to grips with the problem should, if anything, increase demand in the economy. Not to have done anything would certainly have hit confidence at home and abroad.

In any case the much more difficult decisions are to come, first in the emergency Budget now only four weeks away, and then in the autumn spending review, which will aim to set spending plans for the entire parliament.

The Budget has to try to set out some sort of credible path towards eliminating the fiscal deficit over the next five years. That will be extraordinarily difficult; just getting the deficit down to level where it stops increasing as a percentage of GDP would be hard enough. It would have to come down from more than 10 per cent of GDP to something close to 2 per cent of GDP.

But it seems likely that most European governments will bring in even tougher targets and they start from a more favourable position than the UK. This is a convoy in which the ships have to move – more or less – at the same speed and the UK is currently tagging along at the back.

So the Budget will set out not only the tax increases that will inevitably come but also the broad outlines of how much money there will be available to spend. The task in the spending round will be to see how the individual departments can refashion the way they operate so as to maintain public services on less money, in some cases much less money. This is something that has not been done on this scale since the Second World War. It will not be a once-and-for-all squeeze – two or three years of downsizing then back to business as usual. It will go on and on, right through the next five years and beyond.

It is not about politics. It is about mathematics. Currently the Government is spending close to 48 per cent of GDP. Over the past 30 years taxes have never been more than 38 per cent of GDP. The rest is being borrowed, and since interest has to be paid on those borrowings, this makes the gap even harder to close in the future.

In a way, the cuts we have just heard about are the easy bit of the story. The tough choices are ahead.

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