Instead of constantly asking questions about the “cuts”, the question that needs to be asked about the UK economy is why hasn’t the huge public sector stimulus injected since 2008 succeeded in pushing the economy back into growth?
Since April 2008 there has been a surge in public spending and borrowing. In 2009-10 the state borrowed 11.1% of our National Income, in 2010-11 another 9.9% and in 2011-12 another 7.9%. Before my critics point out that borrowing was bound to be higher owing to the poor state of output, let me also give the cyclically adjusted figures which allow for this. On that basis the state borrowed 8.9%, 7.4% and 5.3% of National Income adjusted for the extra borrowing needed for the weak output levels.
This level of extra spending and borrowing is far higher than previous recessions. In the early 80s recession the cyclically adjusted borrowing was 4% of National Income. In the early 90s European Exchange Rate Mechanism induced recession it peaked at 5.5%.
Current public spending has been rising in cash and real terms. Public sector growth has added to the output of the total economy. So no-one can say that the public sector “cuts” account for the disappointing levels of output. The disappointing levels of output are despite the increased size of the state sector.
There are two main reasons why growth has been elusive.
The first is the private sector has been starved of new money to borrow. This has made it difficult to expand business activites and to invest. The broken or over regulated banks have been unable to finance a traditional private sector business recovery.
The second is the high tax rates and the big prices rises put through in the public sector have squeezed people’s incomes, cutting confidence and demand. High rail fares, high energy costs, higher VAT, National Insurance, and Income Tax for those pushed into the upper bands have all conspired to cut demand. Inflation has been a big problem, producing a large fall in real incomes for many.
Because the state needs so much tax revenue, other income and borrowings to feed it, it squeezes the rest of the economy. If the government decides on an extra pound of public spending paid for by a tax increase, that has no overall beneficial impact on the economy. The public sector grows by a pound, but the private sector shrinks by a pound. It is not a stimulus. If the state borrows an extra pound to spend, the private sector cannot spend the pound it lends to the government.
If the state spends another pound which it prints, that can increase total activity in the economy, as long as the extra money goes into more output and not into more inflation. So far the money printing has gone into both, with the price rises offsetting some of the public sector stimulus. The more prices rise, the bigger the cut in real incomes for the private sector, and the bigger the fall in output from the private sector.
The biggest ever fiscal stimulus, Keynsian stimulus, is being tried. It is not working. Instead of asking for a bigger one, more of the same, people should ask what can be done to promote a more buoyant and successful private sector. That, as readers will know, rests on mending the banks, setting competitive tax rates, reforming welfare and tackling costs like energy and transport.