The Budget 2013: No Plan B, No Recovery.

by Henry Cunnison

The effects of austerity on debt:GDP ratio
(source: nytimes)

Since the Emergency Budget of June 2010, the Coalition government has pursued a policy of austerity, believing that it is the only way to help the economy recover from the financial crisis and reduce the budget deficit. Despite the disappointing economic performance since then, David Cameron’s speech on March 7th suggests that the he and George Osborne remain committed to a reduction in government spending; this Budget is no radical change in policy. This is bad news for Britain’s economy.

The Coalition’s policy has not even been effective in reducing the deficit. In the budget he is likely to announce that he further delaying his prediction for the government to be running a surplus, initially 2015-16, to 2017-18. The IMF has recently produced a paper on austerity and its effect on government debt.  Paul Krugman, the Nobel Prize winning economist, used the results to create the graph below¹. What it shows us is that if a country cuts spending by 1% of potential GDP per year; its debt as a percentage of GDP will rise, and only return to the pre austerity levels after 5 and half years, all other things being equal. Although the increase in debt is short term, the IMF concludes that this could cause problems if:

 “country authorities engage in repeated rounds of tightening in an effort to get the debt ratio to converge to the official target.”

George Osborne and Cameron, seeing the failure of austerity to reduce the deficit in the short term, seem to believe more austerity is the only cure.

Nor is the continued austerity even necessary. Before the recession the United Kingdom had the second lowest debt to GDP Ratio of the group of seven economies, at only 38%. The Cyclical adjusted predicted deficit for 2007-8 was a mere 0.7% of GDP and 0.5% of GDP 2008-9. This Budget deficit is not the result of years of overspending by Labour, although Fiscal policy should arguable of been tighter. Instead it was the result of the recession. With a huge increase in unemployment, and reduction in spending, the government naturally operates with a large deficit. So the way to reduce that deficit is not cutting, further increasing unemployment, but spending and introducing temporary cuts in taxes, reducing unemployment, and also, if spent on infrastructure, providing long run growth as well as a short run recovery. In fact in an economics lesson only last week that the standard response to a recession is to increase the budget deficit in the short term. This is not complicated economics, but the coalition is getting it wrong.

Britain's debt: 1922-2011

Why does Osborne think this time is different? Because he believes that Britain’s debt is dangerously high. Yet the country that is embarking on the biggest Keynesian fiscal policy of all, Japan has a debt to GDP ratio double the size of Britain’s. Furthermore Britain’s debt is by no means exceptionally high compared to historical levels. If anything this is the best opportunity for Britain to borrow in living memory, as it is facing a record low interest rates on lending.

 

Britain's economic performance following a recession
(BBC)

Britain now has a unemployment rate of 7.8%, which would far higher if we had not experienced a massive slump in labour productivity. Moody’s has cut Britain’s triple A rating, not because of a high level of debt to GDP, but because of the poor medium term growth forecasts, which could have been avoided. Britain’s economic performance has arguably been worse than during the great depression, as shown in figure 3. Yet despite this George Osborne is determined to cut. He believes that monetary policy and the private sector can take up the slack. Neither could, as Interest rates are up against the zero lower bound (they cannot go below zero without potentially damaging the basic economic operations in the state) and firms are completely lacking in confidence.

Nor or is austerity the Budget’s only flaw. The decrease on duty on beer seems to be a token measure. While alcohol duty is rising at 2% above inflation, Beer is let of the hook. Thus it seems that the government is trying to hide this rise and avoid the anger of drinkers everywhere. Furthermore beer is still over-consumed, and thus the government should be increase the rate of duty on it.

Public sector workers continue to be hit hard. They pay rise will be capped at 1% until 2015/16, and at that time there pay will have been capped for five years. Not only is it wrong that these workers should be expected to pay such a toll because of government austerity, but it will also negatively affect the economy, as the public sector workers will have less disposable income and will also be losing confidence over the continued attack on their wages.

Despite the budget’s continuation of the doomed economic policies of the coalition there are a few positives.

The government’s decision to raise personal allowance on income tax to £ 10,000 will provide householders with more disposable income and thus hopefully lead to increased spending, as well as easing the pressure on the poorest. However this is only a small increase from the current rate of £8105, and many would argue that the level should be higher still.

I also agree with the government’s planned increase in large scale infrastructure projects, which in the long term will expand the economy. However the money is coming from further cuts from most Whitehall departments, which on average will be expected to cut a further 2%, having already had their budgets slashed. What this policy equates to is sacrificing the short to medium term growth of the economy, for marginal gains in the long term, which could easily be achieved with further borrowing. It seems that many Conservatives are using the budget deficit as an excuse to achieve their dreams of a smaller state.

But despite the few positives to take from this budget, it remains unsatisfactory on the whole. Cameron and Osborne seem determined to maintain austerity. I would suggest that they now feel they cannot change their economic policy, for the sake of the political career. Instead of giving us the expansionary fiscal policy we needed, they have continued to give us austerity.  This Budget is not the plan B that was required.