Duncan’s Economic Blog

Osborne’s Dangerous Political Gamble

Posted in Uncategorized by duncanseconomicblog on October 18, 2010

So it looks likes Osborne is indeed going to take the axe to welfare spending in an effort to protect departmental spending. (As I guessed he might).

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.

7 Responses

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  1. Liam Murray said, on October 18, 2010 at 9:55 am

    Back in August, in that same post, you also wrote:

    “Put more money in people’s hands (either through a tax cut or a benefit increase) and they’ll spend more of it on imports (which subtract from growth).”

    Doesn’t that make undermine the point you’re making here – that the fiscal impact of cuts to welfare spending is damaging?

    p.s. Video over on my blog which you’ll find interesting….

    • duncanseconomicblog said, on October 18, 2010 at 10:25 am

      Liam,

      I’ll check out the video.

      On the main point – yes and no. I fully acceptable tha fiscal policy alone can’t fix the mess. But I still think Osborne’s choices risk making the situation more dangerous. (I’d prefer higher investment spending).

  2. Howard said, on October 18, 2010 at 11:32 am

    I think the cuts to welfare spending – particularly the Housing Benefit restrictions and the cuts of up to 80% in the social housing budget (if the leaks turn out to be true) are going to result in thousands of people being homeless on the streets. Maybe that’s Osborne’s big idea – starve the most vulnerable households to death to increase GDP per capita. The policy is like something out of Chris Morris’s “BrassEye” but for real.

    Just absolutely terrifying. What sort of country are we becoming?

  3. pablopatito said, on October 18, 2010 at 12:46 pm

    I think we need to be more clear about our definition of welfare. Despite being well-off, I get various cash payments and subsidies from the state, in the form of child benefit, childcare vouchers, working-tax credits, pension relief etc etc. I see removing these as being analogous to a rise in income tax.

    The idea, banded about by the Tories, that the poor currently pay my child benefit is stupid. I’m a net contributor to the state. The state takes money off me in “tax”, and then gives me a small chunk of it back in “benefits”. I don’t see this as “welfare”.

    Similarly, cutting housing benefit may affect buy-to-let landlords (and indirectly anyone who gains from housing booms) far more than the poor. It may even one day result in the poor being able to afford to buy property in areas badly affected.

  4. Cian said, on October 19, 2010 at 12:41 pm

    Yeah a counter-argument to the cut child benefit argument is that this is simply a transfer from high earners without children, to higher earners with children.

    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.

    True, but he probably doesn’t realise this and wouldn’t believe if somebody tried to explain this point to him.

    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.

    Well they are except for the fact that the economics of it are quite stupid. I mean the Tories can throw this arguments out, but if they’ve managed to throw the country into (what feels like) a recession, then that might not work so well. Labour said that these cuts would lead to a recession, and sure enough… So we’ll see.

  5. Keith said, on October 19, 2010 at 11:30 pm

    Dear pablopatito,

    I do not agree that poor people will gain from Housing Benefit cuts as you speculate ( and others eg C Dillow ) as most social housing tenants are excluded from the property ladder by low/ unreliable income or personal problems which stop or limit access to largs scale credit.

    So the Housing market is “segmented” ie not a single market. The supply of land is also constrained by planning controls as well, hence placing a floor under prices.

    The market cannot secure homes for all; it never has, and HB cuts will indeed together with investment cuts produce hardship and overcrowding and homelessness. Which will of course further handicap the disadvantaged and spoil lives and harm equal opportunities.

    Typical Tory policy helped by the party formerly known as Liberal.

    But Gideon will no doubt be craking open the Bollinger.

  6. Do Ants Dream of Empire? said, on October 21, 2010 at 10:57 am

    I think there are three way to reduce overall benefits costs.

    1) Reduce the number of people claiming benefit by
    a. Economic growth – increasing overall wealth and therefore reducing the absolute number of people who require welfare
    b. Wages distribution – by increasing lower wages disproportionately more people will earn a wage that means they don’t require welfare
    c. More jobs – by creating more jobs even if they don’t contribute much to economic growth per se will distribute incomes more evenly
    2) Reduce benefits to those who are net financial contributors to the state; this is equivalent to a tax rise
    3) Reduce benefits to those who are net recipients of money from the state.

    These measure can be broad (affecting many people, probably a little) or narrow (affecting a few people, a lot).

    I think Labour’s response should start focusing on how the economy will look like in 2015 with a focus on adressing or repairing the situation the country will be in then.

    Being trapped into arguing for higher transfer payments through the government will be difficult when people are struggling with the impact of higher taxes, stagnant wages and public service provision reductions.

    I would argue for a higher minimum wage, which is a transfer from employers to low paid workers. As such it targets the wage distribution aspect of benefit cost reduction.

    Secondly I would argue for an investment in skills. As higher skilled workers add more value they should earn more (and therefore pay more in taxes). Higher skilled workers will have a reduced incentive to moulder on benefits because the difference in potential income between working and not working is greater.

    Helping those on benefit or on the minimum wage to gain valuable skills would lift them up the income scale and it also creates a relative shortage of unskilled labour which drives up wages and makes the gap between unmoderated wages and the minimum wage less.

    I think the investment in skills should probably not be focused on creating more university graduates through large scale state intervention. Instead I would provide employers and individuals tax allowances to provide high quality training that they identify and source themselves. This avoids the state tinkering in macro economic issues but also allows colletive investment in skills and training which have large externalities. It allows individuals and employers to access the skills they feel they need in the short to medium term and to access them in a way that suits them.


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