Home—Blog—Why Britain's public spending cuts are good for the economy
Aug 20, 2010, 12:45
Posted byMerryn Somerset Webb
Comments (24)
Here's a question for you: why is it that, when fiscal stimulus rarely has anything like the positive impact on economies that politicians hope for, is everyone so certain that its opposite (cutting back on government spending) will be such a disaster?
There has been a considerable amount of research done into the effect of government spending or the lack thereof on economic growth. On balance, says Andrew Milligan of Standard Life, the results show a fiscal multiplier of around 0.3-0.5. So a cut back in government spending of, say, 1% would only reduce actual GDP growth by something between 0.3% and 0.5%.
The research also shows that different types of retrenchment have different effects. Cutting spending has a less nasty effect on GDP than raising taxes, for example. It has "less effect on household incomes and confidence", which makes a difference to consumer spending and the like.
At the same time the methods used to cut spending are vital. Retrenching by postponing retirement ages works particularly well. It might not be quite what today's 60-somethings had in mind, but it nonetheless "has the potential to boost GDP growth while simultaneously raising government revenue and spending".
However, possibly the most vital thing of all in this equation is credibility. A government that isn't cutting spending into a sovereign debt crisis, or one that is cutting the wrong things, can easily lose it. And that is worse for GDP growth than almost anything else. Investors and entrepreneurs need to know that they have governments who understand that their job is to create an environment conducive to investment and long-term growth.
Right now, as Crispin Odey of Odey Asset Management points out, in the UK where the coalition is ignoring the can't-cut-now crowd and just getting on with it, we appear to have one. The Americans do not. Which is probably why the pound has risen 15% or so against the dollar since the UK election.
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(20 August 2010, 01:13PM) Complain about this comment
Well done on the remedial economics reminder, Merryn! Empirical evidence has suggested time and time again there IS only one way of ensuring sound economic model, yet the misnomered "Keynesian" model is still touted by those denialists. Inevitably, they end up having to adopt the austerity model eventually. Others have commented how it seems the US is aiming for a future of USSR-style socialist stagnation, whereas ironically China et al seems to be aiming for a more economically-minded future.Odd really.
(21 August 2010, 11:31AM) Complain about this comment
Interesting point on how much goverment spending affects GDP.The result is how half the public money is wasted along the way.
(21 August 2010, 12:13PM) Complain about this comment
Coaliton plans to cut between 600 - 800 thousand public sector jobs surely are not credible? What does the removal of the spending power of that number of people do other than create worse problems?Im not a Labour fan - they royally cocked things up but cuts on the scale Osborne is seeking are crazy.
(21 August 2010, 11:33PM) Complain about this comment
The UK economy is like a brain-dead patient on life support. Labour believe that we must keep the respirator going until the patient kicks back into life, whilst the ConDems believe that the respirator is the problem and turning it off will kick the patient back into life. Both fail to understand that the patient is long dead. It is just a matter of how long before this is realised. Labour therefore offered us the long path to hell, whilst the ConDems will take us on the short path to hell. We will see mass unemployment, house repossessions and civil unrest in the near future.
(22 August 2010, 08:49AM) Complain about this comment
Transitions are always painful, but they need to be concluded quickly and decisively when requiredYes, public sector job cuts will reduce the spending power of those who are fed by wealth sector taxation, and yet more borrowing we cannot afford. But is that not the point?Runaway growth of an inefficient public sector is the issue, not the solution. The longer it goes on, the higher the price to our future prosperity
(22 August 2010, 11:14AM) Complain about this comment
Have a look at this link in case you need further convincing. Stimulus largely wastes yet more money we do not havehttp://www.sprott.com/Docs/MarketsataGlance/07_10%20Fooled%20by%20Stimulus.pdf
(23 August 2010, 12:16AM) Complain about this comment
PJ - A reality check please: It wasnt public sector staff who created ludicrous finanical instruments & stuffed their own mouths with gold incessantly in recent years in the UK. The banking sector have a large role in our recent economic trials. If you take hundreds of thousands of public sector salaries out of the economy - in a short timeframe - you will truely create a major depression.
(23 August 2010, 12:16PM) Complain about this comment
Public sector workers do not produce wealth. They are consumers of wealth. Their salaries, pensions and benefits are paid for by the wealth creators. The more public sector workers there are the fewer wealth creators there will be and consequently the lower will be the national GDP. By getting rid of 600-800 thousand unaffordable public sector workers, who will then have to look for and find jobs that actually create wealth, the economy must grow, GDP must increase, taxation will be less, borrowing less, national debt reduced. Sounds like good economics to anyone.... except socialist thieves and moronic ideological re-distributionists.
(23 August 2010, 12:27PM) Complain about this comment
Richard is absolutely correct - the banking sector has played a significant role in creating a debt crisis. No one could argue otherwiseBut lets also not forget the leading role Goverments and Central Bankers in this whole saga, along with the public and private sectors who have loaded up with more debt than at any time in our history, apparently of their own free will As Merryn suggests, cutting public spending is one positive, efficient measure Governments can take to improve the situation, and doing so quickly should help rather than hinder Factor in the off balance sheet liabilities we are not facing up to yet, and we are only scratching the surface of the public sector debt problem
(23 August 2010, 12:52PM) Complain about this comment
I agree PJ - There is a huge PFI off balance sheet debt for example. JAW - I dont get the logic of your argument at all. Advanced economies are mixed economies. The worry I have is based, for example, on IFS data. If you look at average UK salaries and the workforce you get a totally different view of the economy than that presented by the London media - average salaries at 22,500 for example. Forget the noughties buzzword 'aspiration' - thats over, over,over. If we suddenly cut hundreds of thousands of public roles we severely undermine the UK marketplace. Im not interested in left or right political allegiances here, Im much more interested in what works for the benefit of the majority of ordinary people. They are carrying an average of 4K non mortgage debt on those average salaries before we get to cutting out a whole sector of local economies everywhere which are, inevitably public sector roles.
(23 August 2010, 05:17PM) Complain about this comment
300% increase on an asset class that doesn't produce any wealth in the economy; it's also the largest asset class in the country, i.e. a lot of people made a lot of Sterling (as apposed to money) for doing absolutely nothing. Housing. The Brit disease. Those that made this money from nothing have to give it back, one way or another (taxes, Sterling devaluation, house price declines). The fake jobs created in the public sector (600-800 k) on the back of a housing-bubble economy will also have to be 'given back' from whence they came - from nothing, to nothing.
(23 August 2010, 08:51PM) Complain about this comment
Not sure that the majority of the public sector that Osborne has in is sights is 'fake'. Surely what we need is a pragmatic approach to the deficit. What we are getting is a blatant ideological approach from this government.
(23 August 2010, 09:36PM) Complain about this comment
Richard @ 12:The growth in public sector jobs over the last (say) 7 years is to some extent fake. We were not in dire straight before the jobs appeared and we will survive their passing.Osborne and company are slowly reducing the year on year deficit. Too often people talk as though the national debt was being reduced when in fact it is still growing.
(24 August 2010, 12:15PM) Complain about this comment
Another angle: If we continue to our basic consumer requirements provided by currently low-labour-cost economies we will never achieve a re-balanced economy. Meanwhile as foreign wages, raw materials, and transport costs increase, we will have lost the skilled workforce to deliver home produced goods. Example: the recently reported shortage of home-grown engineering skills forcing UK engineering product manufacturers to locate abroad where the skills can be found in greater abundance.We need a 'buy-British' campaign, not rabidly anti-others, but to remind the purchasing public that buying locally will help in the creation of wealth generating employment, to our long term benefit.I would not accept that this is protectionism, or anti-competitive, just common sense. It would be interesting to see the comparative costs of buying from abroad whilst state supporting an unemployed UK provider, with buying in the UK from that (now employed) provider.
(25 August 2010, 11:38AM) Complain about this comment
Richard,have you not considered that having an economy which is so overly dominated by the public sector creates a serious squeeze on the private sector. Without private sector wealth generation there is no money to pay teachers, nurses, community cohesion and diversity officers, etc. What we have had in the last decade or so under the Labour government is bewildering belief that you can keep spending and never pick up the tab and pay for all sorts of extravagant state involvement. Now the only way is to flush out all of those jobs which are a complete waste of time (and there are loads) to balance up the economy and give this country some much needed credibility. We need to change this lazy public sector culture that is everywhere, of entitlement which is completely out of touch with reality. When you’re spending someone else’s money you don't care where it goes
(26 August 2010, 12:49PM) Complain about this comment
What Id like to see is a balanced argument about this which recognises:a) the billions paid to bail out private sector (banking) utter - utter - incompetence. All documented in detail everywhere for the last couple of yearsb) the PFI bill - thats a private sector solution to public expenditure started by Mrs T & continued - ruinously - by Labour: We have billions of sterling debt herec) the cost of playing world super power when we obviously no longer are one - launching an unprovoked war of choice in Iraq for exampled) and - yes - of course, also public sector waste where that occurs too. Im not a Labour supporter - they were clearly incompetent. But I dont think Osborne's blatantly ideological approach will help either.
(28 August 2010, 02:39PM) Complain about this comment
We continually hear this objection to "ideological" actions by this government. What is wrong with an "ideological" solution to a problem? Surely any course of action should have some guiding principle behind it, whether you agree with the particular course taken or not. The ideology behind this government that seems to be objected to is that it's better not to be in unsustainable debt. I don't remember hearing objections to the "ideological" actions of the last Government, in spending like a drunken sailor, quadrupling the national debt, and generally carrying on as though there was always more tax to bleed out of the population and limitless supplies of money to be borrowed.
(28 August 2010, 05:19PM) Complain about this comment
There was barely any difference between Labour/Liberal/Conservative on deficit terrorismIn a fiat money system the state can simply create money, there's no need to 'borrow' it.It'd be far better to offer a Job Guarantee to anyone at minimum wages, this is the logical extension of automatic fiscal stabilisers and would put a floor under demand and a big boost to business confidence knowing that the state will fund their desire to save/de-lever. Inflation isn't a serious problem whilst the output gap of labour and capital is so large.Check out Modern Monetary Theory at http://bilbo.economicoutlook.net/blog/and read it thoroughly to understand what he's saying...the babysitting model is handy!
(28 August 2010, 09:09PM) Complain about this comment
This blog goes into more detail about the fiscal austerity fallacy of compositionhttp://bilbo.economicoutlook.net/blog/?p=10547I particularly like the dog and bone story!
(30 August 2010, 11:48AM) Complain about this comment
The Australian experience suggests that fiscal stimulus was 2.4 times more effective than monetary.http://bilbo.economicoutlook.net/blog/?p=11270
(31 August 2010, 05:04PM) Complain about this comment
Alan B - Bleeding taxes from people? We let 40 billion go in loopholes to the likes of Phillip Green and his wife every year. If we closed some of the larger loopholes wed be in a better place immediately. The point remains: If you take too many jobs out of the economy in too short a time span, you shaft local economies up & down the country. Personally Im for cutting back on several areas of Labour excess, not least PFIs but also the public sector in general. And I cant let go of the fact that a large part of our financial trouble is caused by bank bailouts - due to utter incompetence in that part of the private sector over many years. However, to eliminate the whole deficit by 2015? Nightmare for the majority of the population : If Osborne gets his way.
(03 September 2010, 01:14PM) Complain about this comment
Government spending multipliers are positive, estimated at around 1.5 in the US, a bit lower here because of higher tax and import leakages, so cutting deficits will cut income and is NOT a good thing.http://bilbo.economicoutlook.net/blog/?p=8252dismantles the Ricardian equivalence/Barro fantasyhttp://bilbo.economicoutlook.net/blog/?p=8252shows the case for government spending multipliers.
(05 September 2010, 12:24PM) Complain about this comment
please why is this myth spread that cuts are neccesary on this scale this a pure rubbish spouted by the right wing media who want to demolish the welfare state and the nhs ,this crisis was not caused by public sector workers the unemployed the sick this was caused by the banks the square mile wall street and the rest of this evil capitilist system ready to implode
(28 October 2010, 04:38PM) Complain about this comment
In Japan Koo reckons the multiplier was 4x in Argentina recently it was 1.6 according to Pavlina Tcherneva...http://www.netrootsmass.net/fiscal-sustainability-teach-in-and-counter-conference/pavlina-tcherneva-l-randall-wray-policy-proposals-for-fiscal-sustainability/
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