This week I want to examine the UK economic strategy in more detail.
The last year has shown that running a very large public sector deficit does not give you fast growth. Those who say we need a bigger fiscal stimulus, a polite way of describing more borrowing, need to explain why the present massive fiscal stimulus has produced so little growth.
Critics of the large deficit, including the government, rightly warn that if the “stimulus” becomes too large markets worry about the level of borrowing and force interest rates up. It becomes self defeating. In cases like Greece and Ireland the borrowing country reaches the point where it is forced into making much larger cuts in public spending because the markets will simply no longer lend on normal terms.
The trouble with the fiscal stimulus theory is it ignores the fact that borrowing is just deferred tax. If the state borrows to spend more, much of the beneficial impact of more spending on demand and jobs is offset. The private sector has to lend the money to the government and cannot spend that same money itself. The effect is similar to the impact of higher taxes, which clearly damage private sector demand. Only if the money is printed or borrowed from outside the country can there be a better temporary stimulus. That comes at the risk of international money lenders putting up the price when they think you borrow too much, and at the cost of future inflation in the case of printed money.
Inflation turns into a tax on the private sector, cutting demand once again, as people can afford to buy fewer items. The combined effect of the inherited inflation, running now at 5% on the RPI, with higher taxes and low wage increases has been a big squeeze on the private sector, bigger than the squeeze so far on the public.
The UK government is correct in saying it wishes to restrain public spending. Its rhetoric of self denial has helped keep interest rates low. The problem is that the restraint in public spending will be more severe in later years than in the first two years of the strategy. This means that the powers of compound arithmetic work against the government, as the early years increases stay with us and increase the base on which future public spending is calculated. In the first year current cash public spending rose by £33 billion, and this year it will rise by a further £24 billion.
The strategy of keeping spending down has also been subject to a number of distractions that have served to boost it in unforeseen ways when the initial Coalition budget was drawn up. The government decided on the Libyan military intervention. It went to the aid of Ireland through loans. It backed a substantial recapitalisation of the IMF. It was talked into increases in the EU budget despite seeking to stop them, as it has no veto on the immediate budget. If you wish to stop public spending rising you need to be single minded in your determination to do this.
The government also decided to have priority areas like Overseas Aid where it wished to put through substantial increases, and sensibly recognised that a large scale reorganisation of the NHS coupled with rising demand for services necessitated increased cash spending.
It has found implementing its good ideas to curb the costs of the overhead difficult. According to one estimate it spent £1 billion in the first year on redundancies. I am seeking to get detailed figures through Parliamentary Questions. Meanwhile it has not taken full advantage of natural wastage, replacing around half the numbers leaving . It has decided to go ahead with two very large computerisation programmes, which will be costly even assuming they are better controlled than previous such schemes in Whitehall.
The mood of many in the country is to get on with the adjustment of spending levels. Some of the government’s chosen areas for increased spending have proved to be more unpopular than some of their cuts, reflecting that mood. As I travel the country there seems to be an abundance of cash available to remodel many railway bridges, to put in a wide array of aggressive kerbs, new paving, restricted lanes, new surfaces and the like. It does not feel as if everything is cut the bone, but in some Councils it does feel as if the priorities are not the ones that many of us would choose.
Reducing the rate of increase in cash public spending can be achieved by relatively straightforward means. The large planned savings in overhead can be brought about by a refusal to appoint any new people from outside, coupled with an active policy of promotion, retraining and movement of people already on the payroll. Expensive redundancies can largely be avoided. The two year wage freeze will help, if sensibly enforced.
The government needs to continue making good progress with its ambitious programme to get more people back to work. Switching people from benefit to work incomes is central to curbing public spending and creating a richer nation.