The chart below is taken from the excellent UK Public Spending website.
It shows welfare spending as a percentage of GDP since 1950. The welfare spending that George Osborne is about to slash, that Labour ran up in order to build a “client state” and which “we can no longer afford”.
In 1997 welfare spending as percentage of GDP was 7.76% , in 2010 (despite a recession and higher unemployment) it is 7.26% – lower than in any year 1979 to 1997.
Yesterday’s post on how some form of state backed investment is needed to both close he deficit and to help reduce global imbalances has provoked some excellent debate in the comments.
The response of some commentators though has left me puzzled – leaving aside the issue of the deficit, I am curious as to how those in favour of free markets believe the UK should respond to the threat of “currency wars”/protectionism/trade war over the coming years?
I understand that their ideal scenario would be unfettered free trade, free floating currencies and minimal government action – but in a real world in which country after country is adopting (or threatening to adopt) measures such as deliberate devaluation, tariffs or export subsidies, what exactly do they propose the UK should do?
The biggest issue facing the world economy over the next decade is the global imbalance between the “over consumption” in the West and “over saving” in the East. The large trade imbalances this causes, coupled with the potentially destabilising flows of hot money are at the root of the threatened “currency wars”. Currency wars which make for a grim outlook for UK exports.
Meanwhile the biggest issue on the economic agenda for the UK is (in the popular imagination at least) the deficit and the question of reducing it.
There is one policy agenda which would tackle both issues – and it’s one that only the Social Democratic left can offer: state backed investment.
The largest driver of the recession was a collapse in investment as the confidence of businesspeople vanished. I’ve argued for a long time that only policies designed to increase investment will ensure strong growth and rising prosperity.
Solving the “investment problem” is the only way to reduce the budget deficit, as long as the private sector is accumulating but not investing a large surplus, as Chris Dillow has frequently argued, then the UK will be faced with a large budget deficit.
David Cameron’s plans for growth speech yesterday, as Hopi Sen has noted, asks the right questions but then avoids answering them. The £200mn for regional innovation is welcome, but no where near enough.
A real growth plan, as Ed Miliband hinted at in his own CBI speech, will require a far more active State. Not necessarily a bigger state, but certainly one that is prepared to intervene more heavily in the economy in order to unlock, and “crowd in”, private sector investment.
Fiscal policy alone cannot, and will not, return the economy to growth. What is required is a far more fundamental rethink of policy and the use of tools that have stood all but idle for three decades or more.
The exact mix of policies required to increase investment and reduce the private sector surplus will vary with the economic outlook, but one crucial component will be some form of state backed development bank (David Miliband certainly “got this”).
A state backed investment bank to fund business investment, a state backed infrastructure bank to fund large scale projects, a state backed green investment bank to fund the technologies of the future could all be combined with state backed venture capital firms to incubate new firms. All of these measures would have one real purpose – to take the private sector surplus and turn it into real assets that increase employment, create high skilled jobs and ultimately help reduce the deficit.
The laissez faire approach of the coalition (essentially, create the right conditions and hope for the best) represents the triumph of ideology over experience. Thirty years of this approach led to a seriously unbalanced economy, one that favoured investment in property over investment in real assets. Without state action to redirect investment, I see no reason that the future won’t resemble the past.
My basic position is that fostering the kind of structural economic transformation and innovation that has been laid bare as essential by the financial crisis is a – maybe the – central public purpose. The private sector cannot make the running here – certainly not yet. We have no choice. A national infrastructure bank that facilitates and channels the excess money in our economies towards, say, new and alternative energy technologies, and the type of infrastructure that might revolutionise manufacturing processes is a worthy pursuit.
But state backed investment, isn’t only crucial to reducing the deficit, it is crucial to controlling the global economic imbalances (as George Magnus notes).
By increasing domestic investment, especially in much needed infrastructure, the UK can play its part in increasing global demand without resort to “export led growth”.
There is a need for this investment and the means to finance it exist in the UK, all that is required is the political will to act.
This CSR appears to be guided more by political economy than economics.
I wrote on Monday that the decision to increase the amount of welfare cuts and decrease the amount of departmental cuts was smart politics, but awful economics.
As we get the detail, it seems even worse. Pensioners, who tend to have much higher savings rates that young people (especially those with families) are being spared. In other words George Osborne has choosen to concentrate the cuts on those most likely to spend their cash. The economic hit will be maximised even if the political hit will be, in the short term minimised.
He is taking the cash from those who actually add to demand, rather than those more likely to vote.
The Keynesian case against cutting during a fragile recovery is by now well known. But, in terms of economic effects, not all cuts are equal – some are more damaging than others.
And all the economic empirical evidence (whether taken from the OBR, the credit rating agencies or the IMF) is that taking money from the poorest will mean the biggest economic hit in terms of slower growth.
This CSR will decrease domestic demand in the economy, lowering consumption and in the long run investment. The picture in terms of external demand already looks dire.
George Osborne is systematically knocking away the drivers of recovery.
We are now firmly on the path of Ireland – lower demand, higher unemployment and lower tax revenue. The deficit will not be eliminated through measures which reduce national income.
The politics of this are quite smart – match (broadly) Labour’s departmental cuts, cut welfare spending and then attack Labour from now until 2015 as the Party that wants to increase your taxes to spend more on welfare.
Now the implementation of this neat little political stratagem will undoubtedly be more difficult in the real world than it sounds on paper. As a simple rule of thumb, try to remember that cutting £1bn from welfare means taking £1,000 a year from a million people. Then think about what cutting £15bn plus actually means – taking £1,000 from 15 million people?
Practical difficulties aside, the economics of this are horrible.
I wrote a post back in August on fiscal multipliers.
One thing leaps out – no matter which set of numbers one uses (IMF, OBR, Moodys) capital spending and transfers to those most in need (AME Welfare in the UK, food stamps, unemployment insurance, etc in the States) – have the highest multipliers.
In other words cutting welfare spending is likely to be especially damaging to short term demand as those on low incomes have the highest propensity to consume and are more likely to spend rather than save their incomes.
Osborne, in an effort to make political difficulties for the Labour Party, is about to embark on a path that is even more economically dangerous than his original course.
The Economist leads today with the developing “currency war”.
Adam Lent, of the TUC, has asked if this might not end up over shadowing the coming austerity.
It should also leave us wondering whether the biggest political debate of coming months and years might not be austerity (or at least, not austerity alone) but how the UK should react to a round of competitive devaluations and, more widely, how it should respond to the rise of China. It might be wise for Labour to start considering its response now.
I agree Adam is right to speculate. This certainly feels bad.
One lesson of the Great Depression, according to Ben Bernanke, is that countries that devalued early returned to grow quicker. The vogue for export-led growth might tempt many countries into pursuing this policy.
The international co-operation that Gordon Brown cobbled together in March 2009 is breaking down with the G20 split on the question of stimulus and split on the question of exchange rates.
A global solution to the unbalanced world economy looks unlikely as countries put their domestic constituencies first.
Flash points at the moment are the US trade deficit (especially in the face of high domestic unemployment), the notion of QE 2 (which to many in the East looks like devaluation by other means), the spat between Korea and Japan over intervention and of course the level of the Chinese renmimbi.
Over the past few weeks there has been currency intervention, or talk of it, in China, Japan, Korea, Brazil, Taiwan, Russian, the Eurozone, Switzerland and India (by my count).
A race to the bottom will help no one.
But being parochial – what are the implications for the UK?
Clearly these developments make the hopes of an export-led recovery more forlorn. Increased currency uncertainty may also hamper the freedom of monetary policy – George Osborne’s only “plan B” if the economy heads South.
Does the coalition have a currency policy? How long will the line that “Sterling is freely floating and its level set by the market” hold if governments ramp up intervention?
We haven’t, in the UK, really had a currency policy since 1992, when Cameron was but a young Spad in the Treasury. Now might be the time to consider one.
… Many appologies for the lack of posts over the past few days.
On the way, probably tomorrow – the Geddes Axe and stagnation.
I hope it’s worth the wait.
The BBC Website is leading with the story “Chris Huhne hints at a shift in public sector cuts”, following an interview given to the Telegraph. I think, as I said last week, that Labour should take this very seriously indeed.
This started on Wednesday with a story in the FT, written by well connected economics editor Chris Giles rather than by their political staff, saying that the Treasury was looking to “reprofile” the programme of spending cuts to due to the “difficulties” of cutting so quickly, such as financial penalties in contracts, etc.
This line of argument has been extended by Chris Huhne who notes that spending cuts could be slowed due to “economic conditions”.
Huhne it is worth noting is a former economist, a former head of a credit rating agency and a member of the “star chamber” having agreed the cuts to his own DECC budget early.
I’m taking these stories seriously and see them as preparing the grounds for a slowing of the pace of cuts.
Some commentators last week couldn’t see this happening – Cameron, Clegg and Co have invested so much political capital in the need to cut the deficit and the “there is no alternative” line that they can’t back down now. I’m not so sure.
Remember the Tories backed Labour spending plans until the financial crisis hit and then totally reversed course at the time of the fiscal stimulus, despite every nearly serious economist writing at that time attacking them.
I wouldn’t put it past Osborne to try a similar political gambit at this stage.
Again, as I said last week, this causes potential problems for Labour.
Obviously we could repeatedly shout “told you so” at Osborne, but I’m not really sure that would feed through to the public mood especially when it means department budgets are being cut by 20% rather than 25%.
And it would mean moving more the pain to 2014/15 and 2015/16, i.e. in the run up to an election. That might help Labour.
But the real danger is what it does to Labour’s response. I’m guessing here but I suspect that Labour’s broad approach under Miliband and Johnson will be to attack Osborne for cutting to quickly and “risking the recovery” coupled with arguing for a halving of the deficit over 4 years using a 50/50 mix of tax rises and spending cuts. Call it “Darling Plus”.
Slowing to broadly Labour’s pace in 2011 to 2013/14 would neatly neutralise the first charge.
Look what this slowing in cuts could do the numbers, and bear in mind that Osborne is looking at £15bn of welfare cuts.
The table below is from an old post.
Note how Osborne is (was?) looking to tighten fiscal policy by £41bn, £66bn and £90bn in 2011/12, 12/13 and 13/14, whilst Labour, using some variant of the Darling plan (either as was or with a 50/50 mix) would be looking at £25bn, £42bn and £56bn.
(Rough numbers to follow, it’s Saturday morning and I can’t face excel).
Imagine Osborne slows to, say, £35bn, £50bn, £70bn.
Now look deeper at what this means in terms of cuts to public spending.
Osborne would presumably be proposing cuts to public spending of around £22bn, £36bn and £49bn.
Labour of £12.5bn, £21bn and £28bn.
That sounds like quite a big difference, and it is. But remember that Osborne has proposed £15bn of cuts to the welfare budget. Subtract that to get the proposed cut to departmental spending (which is the metric Osborne will use) and we get.
In 2011/12 Osborne would claim he was proposing cuts to public services of around £7bn against Labour’s £12.5bn. In 2012/13 the numbers would be £21bn for Osborne against an equal £21bn for Labour and in 2013/14, it would be £35bn for the Government against £28bn for Labour.
In other words, for two years (and possibly longer), Osborne would be able to claim he was cutting public spending in line with the cuts proposed by Labour before the election and at the rate still supported by them now.
This all has to be viewed through the lens of where George Osborne, a very political Chancellor, wants Labour to be in 2015. My best guess – in a position that can be characterised as proposing tax increases to pay for more welfare spending. Slowing down the pace of his own spending cuts helps him get to that position, and I reckon he’ll calculate that achieving that is worth a few weeks of being taunted with “I told you so”.
Labour needs to prepare ways to maximise the advantage of Osborne backing down, without falling into his neatly set trap.
Potentially very big news. The FT is reporting that the Coalition is considering slowing the pace of deficit reduction.
The Treasury is working on plans to “reprofile” spending cuts next April, spreading the pain of deficit reduction more evenly over the next few years, senior Whitehall officials have told the Financial Times.
Confronted with the difficulties of quickly cutting spending – including financial penalties for breaking contracts and redundancy costs – ministers have been forced to consider delaying some of the big savings until later in this parliament.
As Left Foot Forward explains:
Speculation is growing that the Coalition government is about to slow the timetable for deficit reduction. Whitehall sources have briefed the Financial Times amid warnings from the World Bank and concerns from Cameron and Osborne’s Cabinet colleagues.
I, like many others (notably, in the political arena, Ed Balls) have repeatedly warned that Osborne’s planned pace of deficit reduction risks at worst a double dip and at best more sluggish growth than would have been the case otherwise.
The Cameron/Osborne/Clegg “there is no alternative” line has been based around a claim that without rapid action now the bond markets might panic, the UK might get downgraded and borrowing costs would spiral.
Interestingly enough, the FT pieces quotes Ben Broadbent of GS making the opposite case.
Ben Broadbent of Goldman Sachs said that any move to delay spending cuts was unlikely to make “an enormous difference” to the economy or to Britain’s credit rating.
“If people were clear about the reasons for any delay [to spending cuts] rather than suspecting a political wobble … I don’t think [investors] would change their mind about the risk premium on gilts,” he said.
If the Treasury going to slow the pace of deficit reduction (and we should remember none of this is official yet) it’s certainly somehing I would welcoem and something that is right for the UK.
But the politics of it are potentially explosive.
The FT speculates that:
Labour politicians would surely accuse the government of backsliding and the political pain of the cuts would be pushed close to the next general election.
Both of these factors are certainly true – if Osborne slows the pace there will be, rightly, a lot of Labour spokespeople shouting “we told you so” and more the pain will be moved closer to a 2015 election.
But, but, but…
Where does this leave Labour’s response to the CSR in two weeks time?
Surely the really salient political point here is that Osborne is about to throw a handgrenade right into the middle of Labour’s approach.
If he were to slow the pace so that for 2011/12, 2012/13 and potentially 2013/14 he essentially matched the Darling 4 year plan, where would that leave Labour?
Forced either argue for a longer timetable than we one we argued for 6 months ago or forced into backing the overall size of the Osborne plan. It would also neatly neutralise the “risking the recovery” attack as Osborne replied “I’m matching your plans”.
Take this analysis a step further. What if Osborne matches the pace of the Darling plan, but does more of it (as seems likely) through cuts to welfare spending than Labour planned? How do Labour respond? By arguing for higher taxes or more cuts to public services to preserve the existng system?
Osborne’s dream scenario is one where Labour go into the next election arguing for higher taxation to fund greater welfare payments. This takes him one step closer to achieving it.
We need an agreement on a watertight deficit plan and we need ASAP.
As the argument around means testing child benefit heats up, I’d recommend a quick read of the following.
The National Archives have an excellent quick history of Child Benefit. Previous attempts at reform have not been especially popular.
A good example would be 1957:
In 1957, the Chancellor, Peter Thorneycroft, proposed cuts in public expenditure including family allowances. He argued that in removing the allowance for a second child, more money would be available for larger families where nutritional problems were more severe. Boyd-Carpenter effectively presented counter arguments. Thorneycroft resigned after the Prime Minister, Harold Macmillan, vetoed his proposals.
As ever, the IFS have put out a superb and impartial analysis.
A third implication, and the most serious from an economic point of view, is that this reform seriously distorts incentives for some families with children. In particular, adults with children whose income places them below the higher-rate income tax threshold might be find themselves considerably worse off from a small rise in income. This is because such a family would effectively lose all their child benefit as soon as the adult’s income rose just above the higher-rate income tax threshold.
A family with two children currently receives £1,750 a year in child benefit, so a one-earner couple with two children with a gross income between £43,876 and £46,850 would be worse off than if their income were £43,875. Equivalently, a one-earner couple with an income of £43,875 would need a pay rise of £2,975 or more to ensure they were no worse off after paying income tax and national insurance and losing child benefit.
Nicola Smith has an excellent article on Left Foot Forward defending the notion of universal payments.
Today’s announcement is extremely bad news for working families – both those who will no longer receive Child Benefit and those who will now inevitably see the value of their benefits and Tax Credits fall in the future as the principle of universal welfare in the UK is further eroded.
This is going to be politically painful. Ministers are pretty gobsmacked by the chancellor’s announcement, and they fear a backlash. It might not sound like big numbers in the scheme of things but this is a cut which will affect very vocal middle England voters. Mumsnet is also on the warpath. I’m off to a reception hosted by them now. David Cameron and George Osborne are invited – will they dare to turn up? I’ll report back.