We need to cut but do we need to do it now?

Today, George Osborne did one of those verbal tricks where you say that your opponents fall into one of a number of categories, then you shoot down each of those positions, thus showing that all your opponents are stupid:

There seem to be two types of opponent to the Budget.

There are those who deny that any action was necessary.

That we could wait years even before setting out plans to reduce the deficit.

This group of critics would put themselves at odds with an international consensus which understands that the sovereign debt crisis is every bit as dangerous as the financial crisis of 2008, if not more so.

Just because government bailouts helped to calm the markets for now does not mean that the risks have gone away – they have simply been transferred from banks to governments.

Economic stability now depends on a credible plan to restore the public finances to a sustainable path.

To fail to do that would mean higher market interest rates and higher debt interest payments – hardly a foundation for growth.

There is a second group of people who opposed the Budget.

It is those who accept in principle that we must reduce the deficit, but then in practice oppose every cut that is suggested to achieve it.

There is, of course, a third category of opponent; those who accept that cuts are needed, and some who even accept that cuts on the scale the government is proposing are needed, but who think that it’s exceedingly risky to cut so deep so soon.

The Observer’s William Keegan, who I have always thought looks as though he should be wearing a black Stetson and packing two single action Colts, presents some sound arguments for delaying the spending cuts. The best time to cut public spending, he argues, is during a boom, not during a slump. Given that we only started borrowing large sums after the financial crisis and we were starting from a level of debt lower than most other developed economies, we do have a little time to play with. The average length of time before the UK’s debt has to be refinanced is 14 years, compared with nine for Germany and the USA.

The economic arguments for delaying the spending cuts are powerful but so are the management ones. It’s much easier and cheaper to cut costs and restructure when the economy is buoyant. Downsizing an organisation during a boom is a far less onerous task than it is during a slump. People are more willing to take voluntary redundancy, trade unions don’t kick up because they know a lot of people are only too happy to take the money and run. Often the shop stewards are angling for payoffs themselves, which helps to ease the process. During a boom, you often don’t have to make people redundant at all. Turnover goes up and you can lose some people as they simply move on and look for other jobs.

The public sector has a something of a counter-cyclical advantage. In general, demand for its services rises during a recession so, as the economy improves, there is less pressure on resources and it becomes easier to reduce headcount.

The other advantage of downsizing during a boom is that there is more money available to invest. To reduce public spending significantly, the public sector will need to be restructured and its culture and ways of working radically changed. This will be a mammoth task. To do it properly, investment will be needed which may not pay back for several years.

The problem is, as anyone who has tried to change an organisation knows, a boom might be the best time to restructure but there is no imperative to change when times are good. Why do anything differently when the money is rolling in?

The public sector is no different. The mid-2000s would have been the ideal time to completely re-configure the public sector. Sure, the Labour government made noises about efficiency and reform but very little happened. The public sector continued to get its annual real-terms increases and it carried on pretty much as before.

So wouldn’t it do that again if the economy improved? If we waited until the recovery was well under way would there be less of a sense of urgency?

Not this time. Even if we take the most optimistic predictions, the economy will not get back to pre-recession levels until 2014. By that time debt repayments will be running at £67bn per year. Even if our tax base was restored to 2007 levels there would not be enough revenue to return to 2007 public service levels. Other challenges are ahead too; demographics, unfunded pensions and PFI repayments to name a few. Even when our economy has improved, reforming the public sector will still be necessary if we are to live within our means, or at least, within the amout we are prepared to pay in tax, over the next few decades.

The knee jerk stop-the-cuts mob are living in cloud cuckoo land if they think that the public sector can carry on as it is. In the near future there will have to be radical reform of the way we deliver public services. Whether that needs to be done right now, though, is questionable. Taking a large amount of money out of the economy so quickly, and before the economic recovery has gained momentum, is risky and almost certainly unnecessary.

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10 Responses to We need to cut but do we need to do it now?

  1. Pingback: We need to cut but do we need to do it now? - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  2. Cian says:

    Well not really. You could equally raise taxes when times improve. The tax burden in the UK is fairly low. Unfairly distributed maybe, but overall quite low.

  3. Fergus Wilson says:

    Seeing as the last Labour government increased borrowing during seven consecutive years of budget surplus (aka a ‘recovered’ economy) why would anyone believe that they would then start to repay debt if the economy ever does recover? More to the point this myth that the ‘recovery’ is just going to happen like night follows day needs to be nailed. There is no certainty that there will be a demand led recovery and every likelihood that we will have ten plus years of deflation, high unemployment and declining asset prices. The only chance this country and the western economies have to get out of this mess is to SPEND LESS. It’s that basic and anyone who thinks otherwise is probably even now blubbing to some Debt website about being maxed out on ten different credit cards wailing ‘but why did they let me borrow so much?’

  4. Cian says:

    Actually its not that basic. No country has ever got itself out of this kind of recession through cutting spending, except when the rest of the world was booming and they were able to export their way out of trouble (and given that the recoveries were export led, there’s no particular reason to think that cutting spending improved things).

    Currently the UK government can borrow very cheaply and attractively. We have some of the longest term debt in the developed world, and most of it is sterling denominated (which means Greece’s situation is not terribly relevant). We also have high domestic demand for government debt, which has risen during the recession, rather than fallen. So there is no “debt crisis” – the inverse if anything. The reason we have a deficit is due to the financial crisis, prior to which government debt was pretty reasonable (its still not close to crisis levels).

    Secondly anyone who thinks that government debt is like household debt is simply ignorant of economics. Government debt is closer to corporate debt, except that if its denominated in their country’s sovereign currency, its impossible for them to go bankrupt. If you said that a corporation should run a balanced budget you’d be laughed at. If you can borrow money at 3% and get a steady return of 5%, then that’s what you should do. Similarly, if a government can borrow money at 3%, invest that in education (which gives a very good return economically), then the long term GDP benefits will more than pay the interest bills. Similarly cutting back on spending now, only to incur higher costs later (which is arguably the result of cutting back on healthcare, or infrastructure spending) when you can afford to borrow the money is stupid, short sighted and it is robbing tomorrow’s generation for, well, nothing.

    The current debate is stupid because it treats all spending as a cost, which it isn’t. Some spending is a cost (defense being the most obvious), some investment and some spending which would have to be made at some point anyway (repair costs, infrastructure and certain types of capital investment).

    • Bored Bob says:

      You are correct that government debt is not the same as household debt because most households cannot go down to their basement and crank out fresh £50 notes to pay their debts off whereas the Bank of England doesn’t even need to print them it can just ‘create’ £200 billion of crisp new notes electronically. The problem with doing that is someone somewhere down the line has to live with a de-valued currency and hence all other ‘real’ assets – houses, gold, stocks – but not Government bonds – increase in value via inflation.
      The current US administration of course is the ultimate proponent of this Keynesian never never model and if you can keep convincing the world that someone in the future is ultimately going to pick up the tab it’s quite a compelling argument. Eventually however as history has taught us again and again it leads to hyperinflation, economic collapse and social chaos.
      Governments are beholden to their electorates and the people don’t like words like austerity, living within our means and self reliance so if you want another five years in ‘power’ you give them what they want instead which is smaller class sizes, shorter waiting lists etc etc – there literally is no end to what our short term politicians will waste taxpayers cash on. But we cannot afford to keep living beyond our means and if someone doesn’t eventually apply the brakes the next generation or even the one after that will eventually have their bluff called by the international bond markets (a.k.a. speculators). So much for ‘robbing tomorrows generation for nothing’!

  5. Cian says:

    There is no certainty that there will be a demand led recovery and every likelihood that we will have ten plus years of deflation, high unemployment and declining asset prices. The only chance this country and the western economies have to get out of this mess is to SPEND LESS.

    You do realise that Keynes argued the exact opposite, and that countries that have followed your advice have experienced worse outcomes. If public and private spending are both cut, then that inevitably means the economy shrinks (its an accounting identity), unless exports rise (which seems unlikely). And in an economy with falling demand, its very hard to see any mechanism which would lead to the private sector leading the way out of recession.

  6. Rick says:

    Fergus – most economists think there is going to be growth, albeit slow, and even the tax base is showing signs of recovery. What makes you so sure we’re headed for ten years of deflation? There is no evidence to back up your doom-laden claims.

    On the subject of spending cuts, Moody’s has warned the US, Germany, France and the UK that if spending cuts are too severe they could damage growth and threaten the Aaa credit rating – the very thing spending cuts were supposed to avoid!

    http://www.reuters.com/article/idUSTRE67G2PG20100817

    http://uk.reuters.com/article/idUKTRE67M4OM20100823

  7. Rick says:

    Cian – just seen your earlier comment. I don’t believe tax rises in a recovered economy can reduce the deficit alone. Even the most optimistic forecasts don’t predict us getting back to our pre-recession tax take until 2014, by which time demands on the public sector will have increased and the unfunded pensions and PFI laibilities will be looming. We won’t be able to afford the sort of public services we have been used to even after the economy has improved.

    In the medium to long-term we need to completely re-structure the public sector but we don’t need to do it just yet.

  8. Cian says:

    Bob,
    You can’t have it both ways. Either the UK is facing deflation (in which case the BofE has considerable lattitude to print money), or it isn’t.

    As it happensthe Bank of England has been creating new “notes” for the past year and a bit? Without significant inflation (yes inflation is a little high, but that’s a commodities thing that has nothing to do with domestic monetary policy). Japan’s central bank has been printing money for nearly two decades now, and is still barely keeping deflation at bay. So the proposition that if a central bank prints money, then inflation will necessarily result is easily disproven. In certain situations it is a very bad idea (we’re not in one of those), in other situations it can lead to inflation, in other situations its a necessity.

    But its a myth that inflation is necessarily a bad thing. There’s no evidence that even quite high inflation (teens) decreases growth, and anyone who is nota bond holder would be better off with higher growth with inflation, than lower growth without it. Plenty of countries have had periods of very good growth indeed combined with pretty high inflation.

    Eventually however as history has taught us again and again it leads to hyperinflation, economic collapse and social chaos.

    Actually it hasn’t. The closest you can find to this are Zimbabwe and Weimar Germany, but they had a whole bunch of other problems that we don’t have, and are very unlikely to face.

    But we cannot afford to keep living beyond our means and if someone doesn’t eventually apply the brakes the next generation or even the one after that will eventually have their bluff called by the international bond markets (a.k.a. speculators).

    We’ve been living “beyond our means” for hundreds of years, at least by your definition. Gilts are largely bought domestically and most of the demand is from long term investors (pension funds for the most part). Demand has risen during the crisis. We have an extremely long maturity term on our bonds, meaning that any “crisis” point is a long way off in the future. There are limits, but there’s no evidence that we’re particularly close to them. You could even make an argument that given the very low yields currently on offer for long term bonds, governments should be borrowing more now, rather than tommorow when yields will probably be higher.

    Also by your definition companies are living beyond their means and should refrain from borrowing to invest in future production/investment opportunities. Is this really how you think the world works, or do you simply think that all government spending is “waste” (roads? Ports? Schools? Preventative healthcare? Core research?).

  9. Cian says:

    Cian – just seen your earlier comment. I don’t believe tax rises in a recovered economy can reduce the deficit alone. Even the most optimistic forecasts don’t predict us getting back to our pre-recession tax take until 2014, by which time demands on the public sector will have increased and the unfunded pensions and PFI laibilities will be looming. We won’t be able to afford the sort of public services we have been used to even after the economy has improved.

    In the medium to long-term we need to completely re-structure the public sector but we don’t need to do it just yet.

    All of it, possibly not, but I’d guess (without having had time to crunch the numbers) they could take the brunt of it. And don’t forget that current forecasts are based upon the current tax take, rather than what it would be if we increased taxes.

    I’m very skeptical about the scope for re-structuring public services, at least organisationally. My guess, based upon past re-organisations, would be that we’d be lucky to end up with the same level of costs. So far Whitehall has easily got the better of this government who seem unusually naive about how organisations work. Even things like outsourcing, tend to redistribute costs elsewhere, as the only way that outsourcing saves money is by cutting salaries, which means the welfare state picks up the bill in various ways.

    The things that could be done seem to be politically very difficult, or require a level of joined up long-term thinking that doesn’t seem to exist among our lords and masters (on either side of the aisle). So for example there’s considerable scope to reduce spending on law and order by changing policies on drugs and sentencing and increasing spending (difficult) in areas that give a much better return on investment than prisons (very expensive, high redectivism rate) but are seen as soft by the tabloids. In the NHS there’s considerable scope to reduce spending and improve outcomes by rationalising hospitals, but politically that’s very difficult (save our local hospital campaigns). Raising the minimum wage would also increase the tax base (it has a fairly small impact on employment, and may raise it, the evidence is pretty inconclsive either way), while reducing public spending on welfare. Does this seem likely?

    Meanwhile the problem with cutting is if done stupidly, you end up with the outcome from the Thatcher years. Spending not significantly different (higher possibly, once your remove the effects of a debt and north sea stimulus), service considerably worse.

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