“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.” This is the immutable financial insight told to David Copperfield in Charles Dicken’s eponymous classic. The quote neatly underlines the common sense wisdom to spend less than you earn. And as Adam Smith said, “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.”
We can apply this logic to the spending cuts announced by George Osborne yesterday. The Coalition has, as promised, set out £6 billion worth of cuts, including £1.1 billion from discretionary spending and some £600 million from quangos. But these numbers are deeply disappointing.
It is an obvious point, but worth restating, that our deficit is £159.2 billion per year. Every single year, we borrow and spend more than we earn, and last year that figure was more than the GDP of New Zealand. This is unsustainable. Osborne would need to make cuts of not £6 billion but £160 billion to balance the books. Moreover, debt is nasty and it compounds: the government is already wasting a significant proportion of its income servicing debt interest.
There’s another problem too – the kind of borrowing that the government undertakes. Borrowing to buy a house generally makes sense; over the long term, property prices are expected to rise. Borrowing to buy a car, on the other hand, can be a bad idea because cars depreciate in value, losing money. The lesson is that it is sensible to leverage to purchase things that will increase in value (or produce income). However, the government’s spending is worse even than the proverbial car. It borrows to provide services which have zero resale value: the money is literally going down a black hole. Gordon Brown perhaps knew this when he invented the Golden Rule: only borrow to invest. However, it is patently obvious that the Labour government quickly abandoned this principle.
Unfortunately, George Osborne’s announced spending cuts do not even come close addressing the resulting debt problem. The new government, despite the spending cuts, will continue to borrow heavily, risking dragging the UK into a debt spiral. For a government formed of two parties that were so critical of Labour’s economic record, their solution surely cannot be to borrow a feeble 4% less than Labour did in its highest spending year.