Why the real Budget pain is still to come

By MoneyWeek Editor John Stepek Jun 23, 2010

John Stepek

Share with
friends:

Comments (16) Print this article

Well, that's the easy part over with.

After the emergency Budget, no one can doubt that George Osborne really does want to slash the deficit. Labour had hoped to halve our annual overspend within the next five years. He wants to pretty much wipe it out.

So as far as the LibCons are concerned, 'stimulus' packages are out of the window. The government is focused on cutting back borrowing. And it's going to do it mainly by cutting spending (77%) rather than raising taxes (23%).

On paper it all sounds good. The markets certainly liked it. And the broad consensus from the credit ratings agencies is that Britain has protected its AAA credit rating – assuming it can stick to the plan.

And that's the hard part…

Reaction was polarised - but who's right?

Osborne's slasher budget was a "courageous move", said the OECD. Rubbish, said Labour's Harriett Harman. It was "a reckless Budget that pulls the rug out from under the recovery".

Recommended reading

Of course, she would say that. But it pretty much sums up the reaction to the Budget. The pundits line up on two sides. One side reckons that cutting spending will be a disaster and plunge us into another depression. The other side reckons that by keeping interest rates low, and allowing the private sector the space to flourish, we'll end up with a much healthier economy, rather than a currency crisis on our hands.

The fact is, we'll never know who's right. In 60 years' time, whatever the outcome, economists will still be arguing the merits of their own pet theories. Each camp will point to the Great Recession of the early 2000s and be able to come up with arguments that justify their own particular political viewpoint.

Cutting public spending is the right way to go

Our instinct would be to back the cuts. Keeping the bond vigilantes happy is one reason. But it's also about confidence. That might sound odd when we're talking about a budget "bloodbath". But people don't like uncertainty. At least now we know what we're facing - a big squeeze. It might be painful, but it's also much easier to quantify, rather than an open-ended commitment to spend "whatever it takes", with no idea how we'll pay the bill in the end.

And we can't ignore that the threat of sovereign debt default is going to be a big issue in the coming months and perhaps even years. The last thing we want is for Britain to come under the microscope after the markets have exhausted the possible disasters waiting in the eurozone periphery.

Special FREE report from MoneyWeek magazine: When will house prices bottom out - and how will you know?

  • Why UK property prices are going to fall 50%
  • When it will be time to get back in and buy up half price property

On top of that, businesses will like the fact that corporation tax is being steadily reduced in the years to come. As a statement of intent, it should encourage businesses to invest, and allay concerns that they might face a much more hostile political environment up ahead.

The banking levy also came in lower than the banks had feared. And they can hardly complain about being taxed effectively on how risky their balance sheets are. So for now at least, it's highly unlikely to lead to a mass exodus to Zurich.

For the average person, the Budget wasn't all that bad

And in fact, the average person could have been forgiven for coming away from the Budget thinking it wasn't that bad. You can read more of the details in my colleague Merryn Somerset Webb's piece here. But in short, beyond the VAT hike – painful, but delayed until January – and the removal of some tax credits which were hard to justify in the first place, there's not a lot of immediate pain in here.

And it was all quite cleverly implemented. The VAT rise from 17.5% to 20% should be a nightmare for retailers. But in fact, retail stocks went up. Why? Because it doesn't come in until a couple of days after New Year 2011. So if anything, sales will get an artificial boost for the rest of the year as people rush to order their big-ticket items for Christmas.

It also deals nicely with the concerns about how hiking VAT would affect inflation. Because frankly, if inflation hasn't started to dip by the end of this year, then the Bank of England will have to revisit its whole argument about there being too much slack in the economy in any case, regardless of what happens to VAT.

But this was just a start - the really tough choices lie ahead

But despite all the headlines about hacking and slashing, we haven't seen the details of where the real pain will hit yet. And that's when the government's job will get hard. All the toughest choices have still to be made.

All the moves that will cause real unrest – such as public sector pension reform, massive 25% cuts to most departmental budgets, and proper reform of benefit programmes – will come in the spending review in autumn.

As Nicholas Timmins points out in the FT this morning, "with health and overseas aid protected, all other departments face an average 25% spending reduction over just four years."

That means that all the reforms to housing benefit and the like are just for starters. "If we can find any additional savings to social security and welfare… then that will relieve the pressure on these departments, and that 25% figure," as the chancellor put it.

These reforms are needed, as are the cuts. There's no doubt that over the past decade, the government has expanded into areas where we simply can't afford it to be. But it's these reform decisions that will cause the biggest political upheaval. They're also the ones that are the most important to get right.

So all in all, it's not a bad start for Osborne. But the real test for the government – and for the UK economy - is still to come.

Our recommended article for today

It's not too late to buy this fashion high-flier

Don't think a stock is too expensive just because it's hitting new highs. This fashion group is up 34% since its flotation, but there's plenty more to come, says Bengt Saelensminde.

Comments (16)

Published in Economics | More articles by John Stepek

Share with
friends:

Related articles

Comments

Leave a comment

  • 1. stanbowles

    (23 June 2010, 12:10PM)  Complain about this comment

    So, we slash public spending at home and raise taxes, but overseas aid remains the same? Wrong. Just wrong.

  • 2. NVP

    (23 June 2010, 12:19PM)  Complain about this comment

    ask any company or household......whats easier (granted in the short term) to generate more cashflow, cut spend - or try to earn more ?

    A no brainer budget for me .....he should have cut even more.....we were all expecting it, so he should have gone more for the throat everywhere and eased off if needed in next few years

    makes me laugh when I read about people who are worse off after the budget....who did they expect was gonna pay for it ...the fairies ?

    Britain has sent a good message to the markets and they like it.....

    NVP

  • 3. Unsure, of Chancery Lane

    (23 June 2010, 01:01PM)  Complain about this comment

    I fully agree with this statement: "The fact is, we'll never know who's right."

    What I do know is that the CGT rise was a stupid fudge. It should've been resinstated to where it was before Brown cut to a blanket 18%, but with a longer taper to put off the private equity bandits.

    I also know that cutting the education budget is a very bad idea. Cut the number of university places, yes, whilst widening access to the top universities, i.e. get more kids from poorer backgrounds into Oxbridge/Russell Group, whilst re-Polytechnic-ising institutions to cater for local students.

    The rest of the budget was probably necessary.

    However, only a Land Value Tax can truly save us, but the Tories will NEVER introduce one.

  • 4. Day Trader

    (23 June 2010, 01:02PM)  Complain about this comment

    Will someone please explain why we don't cut foreign aid?
    If we want to help other countries that have not developed at the same rate as us why do we not use our political weight to encourage them to attract British companies to set up factories ect and provide employment for the local people. This would also give the local people a sense of pride.

  • 5. Howard

    (23 June 2010, 01:22PM)  Complain about this comment

    I agree the gov't should cut foreign aid. Why we need to pays millions to the China since it is still classified as a developing country? Come on... you know which country is richer, right?

    The cut is not far enough. I should be harder, as people expected, and labour is so weak to fight back. The only problem I believe is the lib dem doesn't want to go too far. Poor Conservative.

    Some radical changes are required. One day I am thinking to privatised every local council, let company to bid for the operation. The only way they can increase income is by attracting residents, i.e. build more homes, and make the society more attractive.

  • 6. Peter

    (23 June 2010, 02:39PM)  Complain about this comment

    They shouldn't have put taxes up.

    They should have included health and foreign aid in the cuts.

    Agree with most of what you say, but the problem with low - ie artificially low - interest rates is that they are part of what put us into this mess in the first place.

    If they continue, they will certainly distort economic calculation and weaken any possibel revival in the economy. Rates like this will certainly lead to malinvestments, like all those absurd inner city flats flats that sprouted in places like Leeds and Manchester.

    This budget would have looked a whole lot better if we can had had no tax hikes - and market led interests...not the kind of thing that people like Mr Blanchflower concoct.

  • 7. r

    (23 June 2010, 02:55PM)  Complain about this comment

    Aim high, miss low.

    I'd say that's the current thinking and rightly so. And if we're very good and hit their targets they'll give us a lolly-pop in a couple of years time.

    I can think of another good wheeze. Float the BBC. Sell it off to the public. after all, we own it, so let's own it properly. The archive is full, and impressive in parts.

    That should raise a few bob.

  • 8. alex

    (23 June 2010, 04:33PM)  Complain about this comment

    Good idea. We could sell Terry Wogan, surely we own him now after all the year the BBC has been paying him?

  • 9. Etienne

    (23 June 2010, 07:20PM)  Complain about this comment

    "The fact is, we'll never know who's right. "

    ... true but we do know labor's predictions on the economy have been consistently wrong and over-optimistic.

    Frankly I have no idea why anyone would take any of their current comment seriously.

  • 10. Jim

    (24 June 2010, 07:05AM)  Complain about this comment

    With quite a few countries having economic problems, I would think there are a few examples for the economic historians to argue over which is the right or wrong way.

    Certian misgivings about overseas aid, perhaps it should be index linked to government income, meaning pay what we can afford to give.

  • 11. Carol

    (24 June 2010, 08:29AM)  Complain about this comment

    I wouldn't be so quick to assume that spending will go up even in the short term. Public sector workers have just been put on notice that their jobs are at risk, so they are likely to cut spending and work on paying down debt. Since they make up a large proportion of the labour force, they could have a marked effect on retail sales.

    And, yes, my husband is a public sector worker (IT staff at a university). We saw the writing on the wall back in 2008 and started preparing, and are debt free. His colleagues are just beginning to realise what's happening and are like deer in the headlights -- and they're drowning in debt. What will happen to them when they lose their jobs?

    Same story will be repeated all over the country. Consumer spending rises? I don't think so.

  • 12. alex

    (24 June 2010, 09:20AM)  Complain about this comment

    Carol that seems like text book management practice to me.

    Threat of loosing your job = absolute terror

    Subsequent announcement of a 15% pay cut ( but no job losses ) = relief and acceptance.

  • 13. Ruth

    (24 June 2010, 11:39AM)  Complain about this comment

    I agree Carol (and yes, I have a husband in the Public sector too).

    The government has underestimated the effect on spending that these cuts will have. Even if there is a pay cut rather than redundancies, workers are not going to spend until they know what is happening.

  • 14. Ruth

    (24 June 2010, 11:39AM)  Complain about this comment

    I agree Carol (and yes, I have a husband in the Public sector too).

    The government has underestimated the effect on spending that these cuts will have. Even if there is a pay cut rather than redundancies, workers are not going to spend until they know what is happening.

  • 15. alex

    (24 June 2010, 11:50AM)  Complain about this comment

    The best analogy I can think of is that man can ride on a horses back, but a horse can't ride on a mans back.

    The public sector is carried by the private sector. If the public sector becomes larger than the private sector then the burden on the economy becomes unsustainable.

    Brown made up the difference for a while with borrowing, but that is finite. Sooner or later, and relardless of the short term consequences the % of the economy that is in the public sector has to shrink.

    No matter what Labour maintain, that is a simple economic fact.

  • 16. Tom O'Neill

    (26 June 2010, 11:36AM)  Complain about this comment

    There is a way to encourage the private sector to take up the slack from the public sector cuts - privatise the services and turn them into marketable choices that people can buy, while lowering taxes.
    And no, we can't know which approach, cutting or spending, will revive the economy. But look at the Keynesian economists who plead for more government spending, and ask yourself: who is financing their jobs?
    In almost all cases, it's the taxpayer.

Leave a comment

This will be the name displayed with your comment.

This helps us verify comments are genuine. It will not be displayed anywhere on the site and is stored confidentially.

Please keep your comment within 1,000 characters and relevant to the main topic. We encourage healthy debate, but we don't allow insults or bad language. Anything off topic or unpleasant, we'll remove. Enjoy the conversation! Thank you.

captcha To prevent spam-related comments please enter the characters shown in the 'Captcha' box to the left.

By leaving a comment you accept our terms and conditions.


FREE - MoneyWeek's daily investment emailJohn Stepek

Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.

>