To cut or not to cut? - That is the question - Admiral PR Admiral PR

To cut or not to cut? – That is the question

The Comprehensive Spending Review (CSR): The right and responsible thing to eradicate the debt within four years so we do not pass on a huge debt to our children and their children or too fast too deep and risks plunging UK back into recession?

I guess that is the question – as Hamlet might have said of the CSR.

The key points of the CSR included:
• £81bn worth of cuts across public sector including all departments (except Health and International Development)
• About 490,000 public sector jobs likely to be lost
• Average 19% four-year cut in departmental budgets
• Deficit to be eliminated by 2015
• £7bn in additional welfare budget cuts
• Police funding cut by 4% a year
• Retirement age to rise from 65 to 66 by 2020
• English schools budget protected; £2bn extra for social care
• NHS budget in England to rise every year until 2015
• Regulated rail fares to rise 3% above inflation
• Bank levy to be made permanent

As a result of the global banking crisis the last UK Government decided to intervene to support the banks’ balance sheets to stop them going bust and further investment in the public sector and to ensure that the resultant recession did not lead to as much unemployment as the recessions in the 1980s of c3million. In the recent recession it was c1.5million. In so doing the Government ran up a deficit of c£160billion or around 11 per cent of gross domestic product (GDP). This compared to compared to the deficit in the USA of 9.7 per cent of GDP. In 2010 the UK deficit is the largest in the G20. This was beginning put pressure on the UK’s credit rating and the markets were considering increases the rates at which it lends to the UK.

Hence the political consensus across all parties to reduce the deficit. The question going into the general election was not if to reduce the deficit but when. Labour said half it in four years. As did the Liberal Democrats, as any quicker, they argued, risked pushing the UK back into recession. The Conservatives said eradicate it within four years. The coalition of the Conservatives and Liberal Democrats have agreed to a policy of eradication within four years.

Before we consider whether this is the right thing to do or risky, first a bit of context:

Three Centuries of the National Debt
The National Debt was made possible shortly after the Glorious Revolution in 1688, when William III arranged to sell debt securities through a syndicate of London merchants. The syndicate became the Bank of England, and the securities founded the National Debt. Looking back over the last century, the debt back in 1900 doesn’t really register. But by charting debt as a percent of gross domestic product (GDP), you get a look at government debt compared to the size of the economy at the time.

The British Empire was built on the National Debt. Throughout the 18th century the National Debt grew and grew, from nothing at the end of the 17th century to about 60 per cent of GDP by the end of the War of Spanish Succession in 1715.

In mid-century the Carnatic Wars in India, the Seven Years War against France and the American War of Independence caused another ratchet in National Debt up to 156 percent of GDP in 1784.

But that was just the beginning. The Revolution in France and the subsequent Napoleonic Wars led to another explosion in military spending and the National Debt rose to 237 percent of GDP in 1816 after the battle of Waterloo. The rest of the 19th century was spent in drawing the debt down, to a low of 25 percent of GDP in 1914. That was just before the outbreak of the Great War in Europe.

National Debt since 1900
In the 20th century the UK government has increased the National Debt to fight wars and to mitigate economic troubles. At the beginning of the 20th century in 1900 the National Debt stood at a very manageable 30 percent of GDP and dipped to 25 percent of GDP by 1914 despite the intervening Boer War. But the Great War, World War I, caused an explosion in the National Debt up to 135 percent of GDP in 1919. Then, in the economic troubles of the 1920s it rose to 181 percent in 1923 and stayed above 150 percent of GDP until 1937. The National Debt dipped to 110 percent of GDP in 1940 before soaring to 238 percent of GDP after the close of World War II in 1947.

After World War II the National Debt was slow reduced down as low as 25 percent of GDP in 1992. Thereafter it fluctuated in the 30s and 40s until the financial crisis of 2008. The National Debt is expected to exceed 100 percent of GDP in the aftermath of the crisis.

The graph below shows national debt since 1945:

In this context a UK deficit of c£160billion or around 11 per cent of GDP is by historical standards – not too bad. However, the threat of a Greek style Government credit rating downgrading has mean that there is cross party consensus to reduce and eradicate the UK deficit soonest.

So back to the question of how fast and deep the deficit should be eradicated. By the current Government’s own admission, cutting so deep so quickly, is a risk. The Chancellor of the Exchequer, Rt Hon George Osborne MP, is gambling and literally banking on the private sector filing the vacuum and creating the jobs so unemployment does not shoot up to over 3m again. His growth projects rely on this.

All UK citizens, regardless of their political persuasion, are hoping he is right. But cutting as fast and as deep is unprecedented. They are deeper than Thatcher’s cust as she attempted to “roll back the State” in the 1980s. Osborne points to the IMF and OECD supporting his programme. But they also supported the Irish Government’s spending cuts and the Irish Economy is now suffering a sustained period of low growth and negative equity.

Osborne also points to how Canada literally blew up public buildings and hospitals in its fiscal austerity measures in the 1990s and they, arguably came out with a stronger private sector, and more balanced economy. However the USA (the biggest economy in the world) was booming then and Canada of course shares a huge land border with the USA. Now the USA is not booming and the rest of the EU is also introducing their own public spending cuts programmes.

Keynesianist economists and those on the left worry that the private sector, because of the fragile global economic situation, will not be able to take up the slack and create jobs to those public sector workers made redundant by the CSR. And the UK economy may slip back into recession. The Labour Party, HM Opposition’s policy is for a “much more gradual, much slower reduction in the deficit,” ie half it in four years. They fear the rush to cut the deficit endangers the recovery and reduces the prospects for employment in the short term and for prosperity in the longer term.

The coalition Government do not want the business community to talk ourselves into a double dip recession which would benefit no one. It is almost our national duty not to talk our economy down. They maintain that there is no alternative to the cuts and that it is the responsible thing to do and in the long run will be the best strategy. I guess we all hope they are right. En va voire….

Chris Kelsey @ccat446

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