Gambling on growth – the budget debate

It’s been almost two weeks since George Osborne presented his emergency budget to the Houses of Parliament. I watched the speech, read the newspaper columnists on both sides, and wanted to stop and think about it before I wrote anything. Some say this is a necessary and wise budget, cutting government spending down to a sustainable level. Others say it is unfair on the poorest and plays fast and loose with economic recovery. I’ve been trying to think about the budget more broadly, in its historical, political and economic context, and here are my observations:

  • Osborne prefaced his speech by saying that his was “the unavoidable budget”. From a politician, words like “unavoidable” are almost never true. Thatcher famously claimed “there is no alternative” to economic liberalism, which is just as foolish as communists saying the workers’ revolution is “inevitable”. A politician making absolutist statements is either out to deceive the public or, more often, is unaware of their own ideology.
  • In Osborne’s case it would be the latter, since his second statement was to lay the blame for the government’s financial straits squarely at Labour’s door. If Labour hadn’t overspent there would be no need for cuts, he suggested, as if the credit crunch had never happened. It’s true that we’ve been living beyond our means and government spending has been high, but the recession is a much bigger factor in our runaway deficit. Every recession sees tax revenues fall and spending increase as more people draw down benefits. There were recessions in the early 80s, early 90s, and the late 00s, and governments of both colours were forced to raise borrowing to compensate:

  • In other words, the Conservatives have come to power. This is a resolutely partisan budget, an undoing of Labour’s philosophy. It’s a rolling out of a small government policy, a switch from Keynesian economics to monetarism, justified by ignoring the cyclical nature of economics and profitting from our short memories. This is no surprise, as that’s what Labour did, taking the credit for both the early 00s budget surpluses, and claiming to have ended boom and bust when the 00s recession came later than usual. Last week Tony Blair even admitted that Labour wasted their first two years in power by trying to reverse Tory policy rather than getting on with running the country.
  • Much of the debate has centred around the planned VAT rise to 20%, and whether or not it is fair. Those on the right say it’s progressive because the rich spend more money, and will therefore pay more in VAT. Those on the left say the poor pay more as a proportion of their income, and that VAT is only progressive if you close one eye and squint at it from a distance. In reality, it’s a moot point: the VAT rise is only paying for the VAT cut that the last government instituted during the crisis in the hope that we’d spend more money. The VAT rise is neither fair nor unfair – it’s just paying back the discount we enjoyed over the last 18 months, making Labour’s VAT cut a kind of advance to prop up consumer spending.
  • A better question on the fairness of the budget is this: who pays more, and who pays less? The answers here are very simple. The likes of you and I pay more, through increased VAT. And business pays less, through a cut in corporation tax. To sweeten the truth of it, there was a new tax on banks, although it’s a tax on bank profits rather than banking activity. It will raise a slim £8 billion, but the cut in corporation tax will offset that loss. In other words, the people most responsible for our financial difficulties are breathing the biggest sigh of relief. In that sense, the budget is very unfair.
  • The other big point of contention is whether or not this budget will prolong the recession, and in a growth-based economy this is perhaps the most important issue. The Conservatives want to cut government departmental spending by 25%. Will this lower growth? Absolutely. Government spending accounts for around 45% of the UK’s GDP. Cutting that spending, Labour were right to point out, removes that income from the economy. (To give just one example, 700 new school buildings have been scrapped. This will save £5 billion, but that was £5 billion that would have gone towards jobs and profits in the construction industry) Given that the UK economy only grew by 0.3% in the first quarter of this year, budget cuts could very directly tip us back into recession.
  • Here’s where we come to the big gamble – government’s contribution to GDP will be slashed, with the expectation that business will take up the slack. Osborne’s budget is a love song to big business, a bid to raise the British economy on the silken wings of private enterprise. If the gamble pays off, then British business surges ahead, our rising growth in GDP towing government finances back towards the black. If growth stalls, then the budget will make things worse, not better. All our eggs in the economic growth basket, so to speak.
  • And that’s where it begins to look dangerous. As I’ve written before, a double-dip recession is actually quite likely. House prices are too high and the property market will begin to re-balance itself any day now. The former head of Shell, John Hofmeister, predicts that oil prices will break the $100 a barrel mark around end of the year. Both of those things would make a mockery of the government’s predictions of 1.2% growth this year and 2.3% in 2011, and the budget would come apart at the seams.
    Last week the Office of National Statistics delayed the release (pdf) of it’s latest quarterly national accounts because of ‘potential errors’. They will now be released next monday, and if they’ve been delayed because they are worse than expected, the emergency budget could be derailed in its first three weeks. Either way, the incoming government has taken a good look at the public’s finances, placed its bets on economic growth, and said ‘double or nothing’.


Update: those delayed GDP figures confirm the UK grew by 0.3% in the first quarter of 2010. Government spending accounted for 0.4% of growth, meaning the recession would have last at least one more quarter without increased government spending.

Update 2: Geoffrey Dicks from the Office of Budget Responsibility, asked if the budget would make a ‘double-dip’ recession more likely, said he didn’t think it would happen, but that “logically the chances of that happening have increased.”


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