UK debt crisis: politicians must wake up and smell the coffee

Britain now faces its worst ever peacetime fiscal crisis, yet our politicians seem incapable of grasping the seriousness of the situation.

Indeed, when Andrew Lansley suggested recently that a 10% cut in public spending would be required under a Conservative government, he was widely lambasted.

In reality a 10% reduction is unlikely to be enough, while Lansley’s proposal to ring-fence expenditure on health, schools and overseas aid will almost certainly be unaffordable. Indeed, this proposal to ring-fence such expenditure means that a 10% cut in other expenditure will not cut borrowing below the current projections at all!

Next year around one in every four pounds spent by the government will have to be borrowed. This is clearly unsustainable and needs to be addressed urgently to avoid jeopardising economic recovery.

All government borrowing crowds out private sector investment and thus government borrowing stunts the much-needed growth of the productive sector. There is also a real danger that debt will have to be issued at much higher interest rates, thus raising the cost of funding and increasing government spending further.

Increasing taxes to address the crisis would not be a wise decision. The tax burden is already at historically high levels and raising it further would discourage economic activity and would be unlikely to raise much extra revenue.

 
A substantial cut in public spending is therefore the only practical option, going far beyond what has been mentioned so far by Conservative Party spokesmen. And to achieve savings of sufficient magnitude it will be necessary to address the major areas of government expenditure: welfare benefits, pensions, health and education. It is difficult to understand why areas such as foreign aid are sacrosanct, given the well-known damage to the development of the poorest countries that arises from the over-provision of aid.

Unfortunately, the “vote motive” means that politicians are reluctant to be honest about the scale of the debt crisis facing the UK. Future generations do not vote and many of those who will bear the burden have not yet been born. The short-term outlook and self-interested behaviour of politicians, combined with an unwillingness to take the necessary action, are likely to have severe long-term economic consequences.

It is ironic that ‘democratic’ politicians are so irresponsible, since they often claim to be ‘accountable’. In financial management matters I believe the two essential characteristics are honesty and competence. Unfortunately most politicians don’t score very highly on either. Perhaps we should regard Gordon Brown as a sort of equivalent of freezing point; and rate other politicians by how much better than him they are. At least he looks likely to have one achievement to his name: making the Conservative party look relatively trustworthy on public finances. Those are not words I ever expected to be writing.

Is the Conservative position on public finances any different from Labour? Do THEY know? I may be wrong but I think the point of the Lansley debate is that the Conservatives have to cut spending by 10% in other departments just to meet the Labour governments own overall deficit targets – which, in itself, still leaves us with a huge structural deficit.

I know I’ve posted this before, but there is no need to cut ‘frontline services’ – we could get spending down by 20% or so by having a cull of the quangocracy.The reason that welfare costs so much is not just because basic levels are too generous, it’s also because of savage means testing – reduce or scrap means-testing and hey presto, more people will move back into work and so the cost of welfare would actually go down.

Mark – I agree that the quangos should be a key target for spending cuts – there is enormous scope for savings. However, I am sceptical of the 20% figure. The Taxpayers’ Alliance released a report last year that estimated quango spending at £64 billion, which is around 10% of public spending (though they excluded NHS trusts from the analysis). Moreover, some of the £64 billion, such as elements of the legal system, could be as difficult to cut back as “frontline services”.

And I am sceptical of the means-testing point in terms of cutting spending dramatically. There are two ways to abolish means testing. One is to withdraw all benefits as soon as somebody earns anything. The other is to make benefits universal (like child benefit). Both of these approaches brings a different set of problems: the first worse incentives over a shorter income level; the second higher tax rates. They might be better approaches than what exists currently and they might save money but they are not “no-brainers”. Time limiting benefits might help. And a transferable tax allowance (or equivalent) might lead to more self-sustaining family arrangements which will help in the long run.

Withdrawing means-tested benefits as soon as somebody earns anything would also make worklessness more attractive than part-time work. We could have a low out-of-work benefit level to begin with, and withdraw it at a rather low rate. The low initial level would ensure that benefit payment does not extend to ridiculously large proportions of the workforce. But I don’t see how that is going to happen under the present circumtances. Somebody working full-time on the minimum wage currently makes about £1000 gross a month; I don’t see how a lone parent in London can get by on much less than that. Now if the benefit level was £900 and the taper 33%, you would need £2700 to get off benefits fully!

To bring down public spending significantly, we would need to drop whole classes of expenditure rather than cheese-pare. For example, aim to cut back over time in direct state expenditure on higher education (HEFCE etc) and move towards a fees-only HE, albeit with a continuing student loan system and a reform of HE working practices to increase productivity. Scrap Winter Fuel Allowance, a condescending benefit which is hugely wasteful when paid to millions of people over 60 who are in full-time work. Do we still need a nuclear deterrent? Or if that’s too much, how about merging the RAF with the navy, as suggested in The Times last week.

I remember debunking Bacon and Eltis on “crowding out” when I was an undergraduate. What’s your evidence of crowding-out.

Michael – I would argue that in the long run government borrowing can’t increase the supply side of the economy. It can only reallocate resources between the public and the private sector. Where is your evidence that government borrowing increases national income?Philip Booth deals with the crowding out issue in Chapter 6 of Were 364 Economists All Wrong?

Richard, the point I’m making is that crowding-out is an empirical question which you can’t pre-empt either way on a priori grounds.Government borrowing as such determines aggregate demand in terms of the excess of public spending over taxation. But quantitative easing can substitute for it. In any case, the headline figure of GBP 2.2 trillion could be paid off by taxing the assets of the Big Three banks: HSBC, Barclays and RBS: aggregate value GBP 5.2 trillion.

Michael – crowding-out may be an empirical question but in practice it is very difficult to measure since there are so many intervening factors affecting outcomes. In such instances it may be necessary to rely on economic theory.

It is ironic that ‘democratic’ politicians are so irresponsible, since they often claim to be ‘accountable’. In financial management matters I believe the two essential characteristics are honesty and competence. Unfortunately most politicians don’t score very highly on either. Perhaps we should regard Gordon Brown as a sort of equivalent of freezing point; and rate other politicians by how much better than him they are. At least he looks likely to have one achievement to his name: making the Conservative party look relatively trustworthy on public finances. Those are not words I ever expected to be writing.

Is the Conservative position on public finances any different from Labour? Do THEY know? I may be wrong but I think the point of the Lansley debate is that the Conservatives have to cut spending by 10% in other departments just to meet the Labour governments own overall deficit targets – which, in itself, still leaves us with a huge structural deficit.

I know I’ve posted this before, but there is no need to cut ‘frontline services’ – we could get spending down by 20% or so by having a cull of the quangocracy.The reason that welfare costs so much is not just because basic levels are too generous, it’s also because of savage means testing – reduce or scrap means-testing and hey presto, more people will move back into work and so the cost of welfare would actually go down.

Mark – I agree that the quangos should be a key target for spending cuts – there is enormous scope for savings. However, I am sceptical of the 20% figure. The Taxpayers’ Alliance released a report last year that estimated quango spending at £64 billion, which is around 10% of public spending (though they excluded NHS trusts from the analysis). Moreover, some of the £64 billion, such as elements of the legal system, could be as difficult to cut back as “frontline services”.

And I am sceptical of the means-testing point in terms of cutting spending dramatically. There are two ways to abolish means testing. One is to withdraw all benefits as soon as somebody earns anything. The other is to make benefits universal (like child benefit). Both of these approaches brings a different set of problems: the first worse incentives over a shorter income level; the second higher tax rates. They might be better approaches than what exists currently and they might save money but they are not “no-brainers”. Time limiting benefits might help. And a transferable tax allowance (or equivalent) might lead to more self-sustaining family arrangements which will help in the long run.

Withdrawing means-tested benefits as soon as somebody earns anything would also make worklessness more attractive than part-time work. We could have a low out-of-work benefit level to begin with, and withdraw it at a rather low rate. The low initial level would ensure that benefit payment does not extend to ridiculously large proportions of the workforce. But I don’t see how that is going to happen under the present circumtances. Somebody working full-time on the minimum wage currently makes about £1000 gross a month; I don’t see how a lone parent in London can get by on much less than that. Now if the benefit level was £900 and the taper 33%, you would need £2700 to get off benefits fully!

To bring down public spending significantly, we would need to drop whole classes of expenditure rather than cheese-pare. For example, aim to cut back over time in direct state expenditure on higher education (HEFCE etc) and move towards a fees-only HE, albeit with a continuing student loan system and a reform of HE working practices to increase productivity. Scrap Winter Fuel Allowance, a condescending benefit which is hugely wasteful when paid to millions of people over 60 who are in full-time work. Do we still need a nuclear deterrent? Or if that’s too much, how about merging the RAF with the navy, as suggested in The Times last week.

I remember debunking Bacon and Eltis on “crowding out” when I was an undergraduate. What’s your evidence of crowding-out.

Michael – I would argue that in the long run government borrowing can’t increase the supply side of the economy. It can only reallocate resources between the public and the private sector. Where is your evidence that government borrowing increases national income?Philip Booth deals with the crowding out issue in Chapter 6 of Were 364 Economists All Wrong?

Richard, the point I’m making is that crowding-out is an empirical question which you can’t pre-empt either way on a priori grounds.Government borrowing as such determines aggregate demand in terms of the excess of public spending over taxation. But quantitative easing can substitute for it. In any case, the headline figure of GBP 2.2 trillion could be paid off by taxing the assets of the Big Three banks: HSBC, Barclays and RBS: aggregate value GBP 5.2 trillion.

Michael – crowding-out may be an empirical question but in practice it is very difficult to measure since there are so many intervening factors affecting outcomes. In such instances it may be necessary to rely on economic theory.

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