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Government spending cuts

The government’s spending cuts: playing dice with the economy?

Abhinay Muthoo is director of the Economic Research Institute and chair of the Department of Economics

Last month, when the Chancellor of the Exchequer, George Osborne, presented his Comprehensive Spending Review, the single most essential ingredient needed for an economic recovery was missing.
It was economic growth.
The Chancellor’s speech to Parliament on 20th October was striking for its proposed spending cuts, which are unprecedented in living memory because of their sheer magnitude and the speed with which they are to take effect.
Yet these dramatic and severe measures were accompanied by almost no policies or ideas for ways to stimulate the economy. For instance, around half a million public sector jobs are to be eliminated, but surprisingly little thought seemed to be devoted to coming up with incentives for the private sector to create the jobs that will make up for these losses or lead to growth.
A few days after the unveiling of the spending review, Prime Minister David Cameron scrambled to address this vacuum. Though his speech focused on economic growth, there were no specific policies or proposals on what the government will or will not do to support and enhance the private sector and the markets.
Too much attention, time and effort have gone into spending cuts compared to the matters of job creation in the private sector and economic growth more generally. Yet, these matters will be the essential foundations of the nation’s economic recovery. The government ought to turn its attention to these matters and soon.
An effective strategy for government would be to look for two main pathways to growth. The first would focus on finding ways to avoid interfering with potential economic expansion. The second would find ways to enable and facilitate job creation. To help create private sector jobs, the government must see what it can do to reduce the overall cost to businesses of employing people. Government needs to seek ways to cut red tape and taxes related to employment. A bold step – though perhaps not as bold as the Chancellor’s spending cuts –would be to abolish the planned increase in employer National Insurance in 2011, because it is, essentially, a tax on jobs.
The government should aim to tackle other job creation costs. In the face of far too much employment regulation, a moratorium on new employment laws for, say, three years would provide a powerful incentive for businesses to create jobs. Slashing corporate taxes and looking to simplify the tax code would be beneficial as well.
Policies and commitments to promote and support the private sector are much needed. The government cannot just rely on macroeconomic measures such as quantitative easing (i.e. printing money to buy government bonds) or on the emerging economies to drive our economic growth. Since Keynesian-type fiscal expansion is not being pursued (due to the structural deficit), labour market policies need to be considered along the lines briefly noted above.
The thrust of the spending review is that total government spending is to be cut by circa £80 billion by the end of the current parliament. This is to be secured by an average cut of 20 percent in each Whitehall department’s budget. Is this warranted? While the main driver for the proposed spending cuts put forward by the Chancellor is to eliminate the structural deficit that characterizes the public finances, one may wonder whether another agenda lies behind these tough and challenging measures.
The government has explained the spending cuts by the need to confront the structural deficit, but another reason may be a philosophical desire to significantly reduce the size of the state. The coalition ought to be upfront about moving towards a smaller state and make the argument why that is good for economic growth and prosperity, for social well being and much more. I haven’t seen any such argument from the coalition government.
In the end, the government will be judged on whether it succeeds in “persuading” the private sector to create jobs and drive our economic growth. This needs to happen soon, as the cuts start.
We can but wait and watch.