Austerity Europe

Whilst the new Coalition government in the UK considers its options for budget reductions next month, many EU countries are revisiting their large public sectors and taking action to bring down costs.

Cutting Ministerial salaries is popular. The 5% UK cut is similar to the cuts in Portugal. Spain has cut Cabinet salaries by 15% and Romania and Greece have also put through pay cuts. Several countries have widened the pay cuts to include senior officials. France has announced a 10% cut in state operating costs, and has frozen total spending save pensions and interest payments. Portugal has stopped certain high profile capital projects. Greece is running a pay freeze for the public sector until 2014 and has cut public sector allowances and bonuses. Spanish civil servants are experiencing a 5% pay cut.

Action is also being taken on pensions. In the Netherlands the retirement age is being raised to 67. Greece is putting the female retirement age up to 65 from 60. Spain is freezing pensions. Romania is putting through benefit cuts.

The profiles for deficit reduction include:

Borrowing as a percentage of National Income

Spain 11.2% 2009 9.3% 2010 6% 2011 3% 2013

Greece 13.6% 2009 8.1% 2010 7.6% 2011

Portugal 9.4% 2009 7.3% 2010 4.6% 2011

The problem for many of these countries is that stuck in the Euro zone without the ability to print money and to devalue, their private sector growth rates may remain poor. Some of them have added to the difficulty by putting through large tax increases. Portugal has imposed an extra 2.5% tax on profits, more than 1% extra on Income Tax and raised the top rate of VAT to 21%. Greece has put VAT up to 23% from 19% and increased Excise duties by 10%. Even Germany, with a lower deficit, has announced no planned tax cuts after all.

More states should be looking for things the government need not be doing, and should be doing more to cut the costs of the government overhead. The EU could make a contribution to getting member states’ budget deficits down by cutting its own financial demands on its members.

Higher taxes on consumption where a country is in balance of payments deficit is less harmful than extra taxes on work and investment. It is all part of the process of cutting living standards where a country has been living beyond its means for too long, relying on borrowed money. In the Euro direct cuts in living standards by cutting pay is more common. In the US and UK cutting living standards by allowing the currency to fall is more common. Sterling fell to $1.46 yesterday, reminding us the markets are not going to wait too long before wanting proof that there is a new strong grip on the nation’s finances.

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21 Comments

  1. Posted May 14, 2010 at 8:17 am | Permalink

    Perhaps we need to be a little more creative with preventing the problems.

    A more radical approach might be to make national budget deficit a treason, with capital punishment applied to the offender.

    Politicians would be far more reluctant to waste money on pet projects if their neck could literally be on the block….

  2. Posted May 14, 2010 at 9:27 am | Permalink

    All sounds very simple, but if Countries lived within their means and not on credit, then much of this pain would not now be required.

    When I think back to the days of a simple pay packet, which was an envelope, with real money in it, no credit cards, no simple overdraft facilites. Life was so much more simple.

    You decided where to spend your money, and once spent it was gone, and whilst this caused a problem for some, it taught the vast majority to budget and learn simple day-day, week-week accounting.

    In other words do not spend or commit to expenditure if you do not have the money, or likely in the future to have the money to pay for it.

    Yes I know this is over simplistic, but the lesson is the same, you cannot spend forever, and put off forever the day of reckoning.

  3. Posted May 14, 2010 at 11:17 am | Permalink

    Unfortuneately taxes on 'consumption'. that is VAT are in operation a tax on business, not sales as we are lead to believe. Consider, you are happy to go and spend say £80 on a meal for two. That includes VAT. You'd be even happier at £68.09, the net of VAT price, but in operation the restuarant would still be able to sell dinner at £80. VAT is a tax on trade, not sales.

    My preference is to cut the taxes on employment (PAYE/NI) and business (CT,VAT,CGT,IHT,SD) and switch it to land. That is is balance out the taxes on the three factors of production of land, labour and capital. In the UK land is not taxed properly, whereas taxes on the factors that drive real wealth creation, labour and capital are taxed too highly. Land does not grow in value, its premium arises from scarcity. Developing land does add value, but if that 'value' is falsely driven by excess credit at too low a price you just get a bubble. (I have aview that the credit 'crisis' was really an old fashioned real estate asset bubble driven by epically stupid policies of various international governments and 'regulators').

    So, lets try and damp out bubbles by linking land taxes to, say, unimproved land values, and at the same time massively reduce taxes on labour and capital.

    I have two employed employees. One takes home a net £730 pcm but we pay about £145 PAYE/NI for her. She then claims tax credits of about £150 pcm. Clearly this is mad. Action now please Mr R.

    • Posted May 14, 2010 at 11:27 pm | Permalink

      Action will start in the June/July budget with an increase of around £700 in the personal tax allowance.

      "One of the Lib Dems' flagship policies was increasing the tax-free personal allowance to £10,000… The new proposals will allow you to keep more of your income before tax and reduce the need for government top-ups. This should trigger a spin-off saving, by reducing benefits and cutting bureaucracy." – per Anne Redston,
      Professor of tax law, King's College London http://news.bbc.co.uk/1/hi/business/10111201.stm

    • Posted May 15, 2010 at 12:14 am | Permalink

      A Land Value tax? What a cracking idea – how about it John? you could then slash income tax to encourage enterprise. I believe Churchill was a supporter of LVT wasn't he ?

    • Posted May 15, 2010 at 1:13 am | Permalink

      I'm not happy spending £80 on dinner for two. Our household income is 50k and yet we had to give up this activity some while ago. I don't know how so many people can afford to do it but the restaurants are packed.

      It's as though we jack each other's wages up by charging the highest price we can get away with … especially on housing.

      For most people, to have anything like what is considered a normal life, credit is essential. It's been used to mask declining standards of living in Britain for decades now. Governments have got away with murder because of it.

  4. Posted May 14, 2010 at 11:42 am | Permalink

    John,am in total agreement with the theory.However and it's a big one,the manufacturing base of this country is now down to about 12%.With choked off investment, no savings and capital taxs how are we going to expand production to service the new market.As I've said before, service industries are a product of real wealth and if we pursue hounding the pension,banking and insurance industries to death and drive them to Singapore/Hong Kong or Dubai we have nothing to sell.Political waffle is now all we get.No nuclear power…bit tricky this if you need an electric furnace, or an electric car.No expansion of Gatwick or Heathrow or high speed rail, and talking of hsr, how have they managed to turn laying two pieces of steel along parallel lines into billions of pounds of investment.The Royal Corps of Engineers could do the job with 50 men and a good engineer.
    I am more convinced now than before the election that failing the lights going out, or a close run with food rationing nothing, will be achieved.

  5. Posted May 14, 2010 at 1:07 pm | Permalink

    Printing money and devaluing the currency mean only one thing, inflation. When will the Govt stop pretending to have a 2% inflation target?

  6. Posted May 14, 2010 at 2:35 pm | Permalink

    How much do other EU countries pump into their Union Modernisation Funds?

    I wonder if Gordon Brown would be preapared to take a haircut on his pension to set an example to other MPs to do likewise? (after all, the problems started on their watch)

  7. Posted May 14, 2010 at 3:16 pm | Permalink

    Sarkozy threatens to leave the Euro.
    http://www.guardian.co.uk/business/2010/may/14/ni

    Yet another instance of our 'partners' solidarity. More like rats in a sack if you ask me.

    And France demands that Germany foots the bill. That worked out well the last time that was tried …. NOT.

  8. Posted May 14, 2010 at 3:19 pm | Permalink

    JR: "Cutting Ministerial salaries is popular. The 5% UK cut is similar to the cuts in Portugal."

    Talk about spin.

    A back bencher gets £64K per year, once selected for ministerial position that individual gets a rise of about £60K to a salary of £120 thousand per year.

    So instead of a five percent cut, a new minister has just got a 100% pay rise.

  9. Posted May 14, 2010 at 7:28 pm | Permalink

    We've been resurrecting and re-coding our growth models to build in realistic negative feedback flows for the sovereign debt problems.

    The figures run roughly – Uk needs 60bn reduction in public spending year on year for 5 years to get out of the woods. If reductions are less than 40bn by the end of 5 years all our growth will be spent on interest rates and we will be in continuous debt. That's because with the debt at 100% of GDP the growth in GDP gets offset by interest. So with growth at 3% and interest at 3% we get no positive feedback.

    So £60bn is the magic number we'll be looking for on budget day. I also think we'll be looking north of a million unemployed as a result. Bottom line is that Labour grew the public sector much faster than the private sector. In fact in most of Europe politicians have been spending the public's money to stay in power at a rate that was going to run it into the ground.

    As a note of caution we all feel that when the Conservatives new public accounting body quantifies the off balance sheet debt it will lead to even larger budget reduction – in the region of 75 billion in 2012. Ouch.

    • Posted May 15, 2010 at 12:22 am | Permalink

      Is someone going to quantify all the PFI liabilities? hooray! but wait a minute – liabilities to whom? ahhh – so-called "private enterprise" (I think the yanks call it "pork barrel" or something). So our taxes are being given to large corporates who out-negotiated a dim government on long-term capital contracts? Hidden subsidies or what? Why do we need an "enterprise package" when we have PFI? Whose side are the Tories on anyway?

      • Posted May 15, 2010 at 10:24 am | Permalink

        Billy B

        Agreed, just shipping out the same number of contracts or jobs to the private sector does not cut expenditure, it just moves the money/payment around. The taxpayer still pays.

        Off balance sheet borrowing or future mortgaging should not be part of any business model, and should be shown as a matter of proceedure in all Accounts, otherwise the true state of the finances is an absolute farce.

  10. Posted May 14, 2010 at 9:30 pm | Permalink

    In drawing up the new budget I hope we tell the EU that our contribution for the next financial period will be 10% less than the current year.

    Its about time the EU started cutting costs, and produce some audited accounts.

  11. Posted May 15, 2010 at 12:33 am | Permalink

    In large part I agree with lola on land taxes. Its hardly fair to tax people on the incomes which they've earnt; wealth that they have n't earned such as windfall increases in the value of residential land plots is another matter.
    More to the point I cannot see that cutting down on the money in circulation is necessary at this critical juncture.There are places in the UK where 70% of the people derive their income from welfare payments or public service employment. There is no suggestion that these public sector provisions have crowded out the private sector.Instead the private sector has not turned up,even to take advantage of the pump-priming done by the public sector.To cut the public sector with no guarantee that the private sector will provide equivalent incomes is evil.

    • Posted May 15, 2010 at 11:10 am | Permalink

      DBC Reed ,

      You make a good point that there is no private sector employment to take up the slack in many parts of the country .

      The money which should have been set asside during the last 40 years to prepare for the future has mainly been wasted and we have already borrowed our childrens money to support todays lifestyle .

      Offshore outsourcing , importing products , services and immigrant labour and excessive concentration of wealth amongst the few have had an adverse effect on the majority .

      As a nation how are we going to fund investment in job creating industries ?

      Should the public sector be given the opportunity to vote for pay cuts to protect jobs as has happened in the private sector ?

    • Posted May 15, 2010 at 5:17 pm | Permalink

      There are certain areas where the private sector simply cannot afford to turn up to compete. One area is in Childrens' Nurseries where subsidies such as no rates, etc. make competition unsustainable. I know of one firm that is going under because the Local Authority has ring fenced an existing Nursery by several of their own. Another is Charity shops where they buy in goods for retailing and undercut local shops because they pay little of no rates and use volunteer staff so that they are not subjected to the horrendous Employment Legislation.
      Provide a truly level playing field and you will see many changes.

    • Posted May 16, 2010 at 2:04 am | Permalink

      DBC Reed: "There is no suggestion that these public sector provisions have crowded out the private sector."

      Of course it has. People who are paid to do nothing, do nothing – worse, many do counterproductive and often illegal things with their free time.

      Now Mr Reed may use this assertion to say "look at the nasty right winger" he wants to cut welfare to the poor. Well, when somebody has been on welfare for a decade, sometimes two then, yes I want to cut it.

      On the other hand, those people who are invalided or chronically ill, no I don't.

      DBC Reed: "Instead the private sector has not turned up,even to take advantage of the pump-priming done by the public sector."

      Because at the level it is economic to start a business in these areas, the private sector cannot compete with the welfare paid to long term welfare recipient. These people have usually been failed by the State education system, so many are not even employable, often can't be bothered to turn up for work on time and in many cases – can't do simple arithmetic nor read or write.

      That is the triumph of the Welfare system Mr Reed advocates.

  12. Posted May 15, 2010 at 2:22 am | Permalink

    Quite. Everyone has recognised that National Income is not going to go back up overnight so public expenditure has to come down or taxation has to go up, or both.

    Our export led recovery will only happen if the relevant private sector companies are able to borrow to invest. The same goes for import substitution. Given Europe's cut backs, it may be that import substitution is more important in our trade with them, with exports increasing to the rest of the world.

    Given the extent of our own problems, we can afford to back the Greek rescue with a €13 billion guarantee. If that contribution is obligatory under the Lisbon Treaty, then the Lisbon Treaty has to go. There may be an opportunity to go to the country in about December on that very issue, provided that we watch the polls and prevent our leader from changing the constitution.

  13. Posted May 15, 2010 at 2:23 am | Permalink

    Sorry: Final para "…………….we can NOT afford ……………."

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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