Hugo Radice on the on-going crisis

Hugo Radice: Risky and radical cuts policy is at mercy of global events
Yorkshire Post
09 November 2010
MUCH of the debate on the Comprehensive Spending Review has focused on whether the resulting pain will be equitably distributed between rich and poor. The Institute for Fiscal Studies, regarded as the most objective of the think-tanks, quickly announced that the cuts would impact more heavily on the less well-off, taking into account not only taxation and welfare benefits, but also their greater reliance on public services whose availability, cost and quality will surely not be sustained.

While there is considerable support for reducing the deficit, many argue that a greater proportion of the reduction should come from higher taxation, especially of the very rich and the banks, rather than cuts in spending. Although the Government is maintaining Labour's 50 per cent income tax band on incomes over £150,000 a year, the dominant Conservatives are adamantly opposed to further increases in taxation of the rich for fear of damaging incentives.

Evidently, Disraeli's "one nation" is dead and buried: cutting the incomes of the rich would lead them to stop working, while cutting the incomes of the poor would encourage them to start working.The other area of debate concerns the economic causes and consequences of the cuts. The Chancellor continues to maintain that the parlous state in which Labour left the public finances left him with no choice but to cut the deficit quickly and deeply. In placing all the blame on Labour, he glosses over the undeniable fact that the largest part of the deficit arose from the bank bailouts of 2007-9. Yet, internationally, the measures taken by Gordon Brown and Alistair Darling were hailed by political leaders and bankers alike. The best that can be said for the Conservatives' own policy prescriptions during the banking crisis is that they were confused, unwilling to endorse the policies of an increasingly unpopular government, but unable to offer a coherent alternative. In addition, Mr Osborne's repeated claims that the bond markets were on the brink of pulling the plug on UK government borrowing prior to the election are not credible, given the ease with which successive issues of government debt have found willing buyers at remarkably low yields.

In any case, there remains a clear risk that public spending cuts will trigger a further economic contraction. Even though the implementation of the cuts is to be spread over four years, the prospect of massive job losses – perhaps 600,000 across the public sector, with consequential further losses in private firms that lose government orders – is enough, it is argued, to damage confidence and reduce the willingness of households to spend, and businesses to invest and to hire new workers. Already at the time of the emergency budget, many commentators pointed out that the new Office for Budget Responsibility was forecasting economic growth much faster than warranted by the historical evidence of earlier recessions.

In view of these criticisms, we can surely surmise that the underlying reason for the cuts lies more in the long-term political objectives of the coalition: reducing the scope and scale of the state, especially through a shift away from universal rights and benefits, and promoting the Big Society. Whether the British public, normally so sceptical of fervent political ideologies, will embrace this radical shift remains to be seen.

There are nevertheless some more hopeful signs for the Government. Despite the fears of renewed recession, the evidence remains mixed. Economic growth continued in the UK in the July-September period, albeit at a slower rate than previously. In Germany, the economic powerhouse of Europe, a more substantial recovery seems underway, while the Obama administration the USA has embarked on a further monetary expansion which, despite opposition from the resurgent Republican right, has been accepted with equanimity by the bond markets. Above all, the emerging economies, especially China and India, have grown so rapidly that they can now provide significant markets for the rest of the world.

In the bigger picture of global recovery, much depends on how world leaders handle the tensions over trade imbalances. There are fears that the major economies are manipulating their foreign exchange rates in order to capture larger shares of world export markets, and that this could lead to a breakdown of collective policy-making in the G20. But these fears are surely unfounded, not because great wisdom can be attributed to the G20 leaders, but because the world's major businesses depend so much on international trade and finance to sustain their production and profits. They are resolutely opposed to any breakdown in the global political dialogue that would threaten their ability to trade and invest wherever they see opportunities. If the new Republican majority in the US House of Representatives seriously threatened protectionist measures, the business and banking lobbies would soon cut off their flows of political funds. On such apparently distant considerations the success of the government's economic policies now rests.

Hugo Radice is a senior research fellow at the University of Leeds.