Tuesday, May 25, 2010

Much ado about 1%

The big news in the UK yesterday was the announcement of £6.2 billion in spending cuts by the government in the current year. It's a cut that both sides of the House of Commons are not being fully honest about. How many lies or evasions of the truth are there? Let's count:

Lie number 1. The Labour Party is claiming that these spending cuts are about "taking money out of the economy" and will precipitate a "return to recession". There is no evidence that running a deficit that is as high as 12% of GDP (higher than Greece) bolsters the economy. In fact quite the opposite. After all, if running huge deficits saves the economy surely it should be steaming along, when in fact in the last quarter it grew by 0.2%.

Allister Heath in City AM proclaims the arguments in favour of continued the high levels of deficit spending are "intellectually bankrupt, pseudo-Keynesian" as the bloated state crowds out the private sector. Why? Because when the state borrows on such a scale, it does so by issuing sovereign debt. It has to do so at market interest rates to attract investors, so it attracts investment from the private sector, in everything from manufacturing to services to banks seeking deposits to boost their own leverage. One of the leading lights of leftwing journalism in the UK - Polly Toynbee of the Guardian - shows up her own economic illiteracy in saying "If Europe causes a second dip, cutting is a bad decision; if Treasury receipts strengthen, then such deep cuts so fast may not be needed." So it is NEVER a good idea to cut government spending according to socialist Polly.

You see the British government is dependent on private investors lending it money to pay for current spending. If confidence lapses in the government's ability to do so then witness Greece. One need not be a libertarian to see how unsustainable fiscal profligacy is. In a world where the term "sustainable" is a buzzword thrown about promiscuously like the favourite harlot of the age, it is curious that most don't understand it outside the platitudes of environmentalism.

So Labour is dead wrong, and largely to blame for the current set of affairs (most of the deficit is not about bailing out the banks, but about the collapse of tax receipts to prop up the bloated state built up by Blair and Brown, and overextended by Brown in recent years). Yet before the election it didn't completely shy away from cutting spending.

Lie Number 2. Labour wouldn't have cut spending. You see Labour did pledge to halve the deficit in five years, which would have meant a sustainable reduction in spending of at least £20 billion per annum. While Labour wouldn't cut spending in 2010, it would have been under enormous pressure to impose significant cuts in 2011. However, its new Great Leader will no doubt simply oppose cuts regardless of the 2010 Manifesto.

Lie Number 3. The savings are all going to cut the deficit. No. £0.5 billion of the savings are actually going to be spent elsewhere and used to start some tax cuts. The latter will be a miniscule boost to the economy, but in essence it sends the message that cutting spending means having money to spend elsewhere. It doesn't while you still have a budget deficit, especially on this scale.

Lie Number 4. The cut in spending is substantial. No. The saving of the total UK budget is less than 1%. Yes that is all that is being saved. It tells you something that total UK government sector spending is 100x this. That comes to the real issue. The budget deficit this year is £163 billion. Less than £6 billion off of that is 3%.

Shifty evasion number 5. There will be further cuts, but this was the hard part. No. Even an optimistic view about the economy, which given the crisis in the Eurozone (which is easily the UK's biggest trading partner) is unlikely, would likely generate sufficient tax revenue to cut the deficit by between a third and a half over time (time during which debt will have increased and the debt servicing costs as well). So there needs to be, at the very least, cuts 12x those implemented yesterday.

Shifty evasion number 6. Future cuts can be made through "efficiency savings" and "trimming budgets". No. Let's assume there needs to be cuts of around £105 billion in spending. You could not do that without hitting some combination of welfare, education, health, defence, or cutting public sector salaries. In other words, significantly limiting the welfare state. The "pain" has just begun, and the dirty little secret is that the UK welfare state as it stands is unaffordable and unsustainable. At some point hard decisions are going to have to be made such as:
- Will health and foreign aid both remaining untouchable areas, both with real increases in spending?
- Should public sector salaries be cut by up to 20% on average?
- Will tertiary sector funding increases have to come entirely from fees?
- Will pensions and welfare benefits be frozen or cut?
- Will middle class welfare, such as winter fuel allowances for the elderly be severely curtailed?
- Will government housing expenditure be halted?

The Conservatives probably know that, and also know that having the Liberal Democrats part of the government that does some of these will help spread the political blame.

However, the public still remains ignorant of the scale of the problem. Which brings me to:

Incompetent explanation of the need for spending cuts. George Osborne as Chancellor of the Exchequer has done a shocking job of selling the need for cuts. He hasn't explained that interest rates could rise if cuts aren't made, he hasn't explained that a bloated state does not allow the private sector to grow, he doesn't convincingly make my first point above, that continued deficit spending is NOT about keeping the economy going - it takes money from the private sector to make the state take it from taxpayers in the future.

What the 1% cut in public spending means is simply a sign of willingness to take steps to deal with Britain's fiscal catastrophe. It is seen as a first step, but sadly is being portrayed as "taking the tough decisions early".

The cuts announced are easy and obvious, although a minor point is that it is odd for government to cut spending on roads when it doesn't allow the private sector to enter the market (and already recover revenue 4x that which it spends on roads from road users).

On top of that it is nice to see the UK doesn't have privatisation -phobia like New Zealand does.

The Royal Mail is to be part-privatised (49%) to raise money and to get private investment into the firm. Far more interesting is that the government is considering a serious proposal to lease the entire motorway network to the private sector.

6 comments:

Jeremy Harris said...

I'd suggest the problem of state spending will soon be dwarfed by the shinking in the world economy that energy scarcity will cause... 12x cuts? - you ain't seen nothing I reckon...

Tony said...

Good Post Liberty Scott.

I actually think the new UK Government is making a huge mistake by not dumping the need for more serious cuts in state spending on Labour right now. As the "Two Sealed Letters" story reminds us, this is their biggest single opportunity to justifying a change to the mindset of what governments should, and should not, do. I agree they are blowing their best chance and attempting more serious cuts later in their term will be much harder (probably fatal to this government).

As to the your prediction Jeremy, well good luck to you. I suggest you purchase long term oil futures right now while the price is low . . . you will surely make a fortune and be able to retire early.

Me, well I have been around long enough to remember EXACTLY THE SAME PREDICTIONS about energy scarcity being made in the 1980's ... a shortage period followed by a long glut (and economic boom). Predictions are actually very difficult ... especially about the future :)

Jeremy Harris said...

While it may sound like a tired cliche I believe "things are different now", the number of peaked countries, the growth in demand in the BRIC countries, the fact we are talking seriously about large scale deep sea drilling and tar sands as sources all lead me to believe scarcity is within the next 20 years...

To be perfectly honest whether through peak oil or carbon pricing or the US dollar tanking (which the history of fiat money tells us it must do) I think Libertarians are going to get their wish for greatly reduced state spending in the next 50 years after some sort of economic decline... Whether this leads to increased state control or not is another matter...

The next few UK budgets and budget projections will be very interesting...

Tony said...

It is my understanding that the US removal on the ban of off-shore drilling has more to do with recognising they are the only major country to have such a ban and that they are actually forcing themselves to purchase oil from overseas (ironically a large amount of which is from off-shore Venezuela and the Gulf state wells). The US is likely to find new reserves off-shore similar to those recently discovered off Mexico and Brazil.

The story is even better for Natural Gas where improved drilling techniques has made a mockery of "Peak Gas" predictions.

As for the coment Libertarians are going to get their wish for greatly reduced state spending in the next 50 years after some sort of economic decline, it is my observation that any link between econimic decline and state spending is more likely to be towards increased state spending (see Japan, once an icon of free enterprise with small government spending and now the 2nd highest government debt level as % of GDP in the world).

If economic recovery is what you want, governments must first cut spending to free up resources (especially private capital ... now there is a resource in short supply) to enable more productivity come from the private sector.

Jeremy Harris said...

I don't want to get into a peak oil debate Tony as that was not the point of Liberty's post but much of peak oil literature focusses on dispelling the two darlings of those that think the party will continue into the forseeable future, they are; discovery and technology... Discovery peaked in 1965 and technology does not increase recoverable reserves...

I see a world where one, two or possibly all three of the factors I mentioned earlier lead to a large decline of world GDP and government finances may reach the point where they are simply incapable of supporting the services the public expects - new models will be looked at at that point, monetary policy being the first change I'd guess...

Matthew said...

Hopefully 2011 will be the year NZ votes away its privitisation phobia.