Saturday, 26 June 2010

Twice As Bad As Thatcher

by Michael Burke

The Budget set out by the new ConDem government will indeed be worse than the Thatcherism which inspired it. It has been widely criticised in main media outlets for its unfairness, even in the Daily Telegraph. Nick Clegg squirmed beside David Cameron as he admitted to a woman firefighter in a TV audience that the freezes to pay and benefits were real cuts.

The openly class warfare character of the Budget is the cause of establishment concern. Cutting public sector pay and jobs, cutting services as well as disability and housing benefits, while hiking VAT are a direct assault on the incomes and living standards of those on average incomes, workers and the poor. Doing this simultaneously with cutting the progressive Council tax, reducing employer’s National Insurance, raising the threshold to £5 million for Capital Gains Tax and reducing the corporate tax rate towards 24% demonstrates who are the beneficiaries - businesses, high-earners and the wealthy.

This series of tax cuts also belies the idea that the paramount objective is to reduce the deficit. By FY 2014/15 these cuts, a transfer of wealth to business and the rich, will amount to £10.1bn annually. By contrast the hike in VAT alone will yield £13.5bn. By that time the reduction to benefits will amount £30bn per annum (all data from the Budget 2010 Redbook unless otherwise stated). Public sector pay will increase below inflation for those under £21,000 a year and be frozen completely for those above, a cut mounting to £3.3bn annually. More is threatened from a review by John Hutton, Blairite former minister for work and pensions.

This is a reordering of society and is neither intended to nor is likely to achieve deficit-reduction.

Attacks Compared

The comparison with the experience of Thatcherism is a useful one. After 10 years in office the first Thatcherites had reduced total managed expenditure (TME) by 5.9% of GDP, or by £83bn in contemporary prices. The coalition’s aim is to reduce TME by 7.7% of GDP in 6 years, a real cut of £108bn. Even this understates the case since there are already cuts being enacted in this year of £8.9bn, for a total of £117bn.

But there is an important point glossed over in the official presentation of the Budget, which is that TME includes debt interest payments, which are clearly not government spending that provides services or creates jobs. These interest payments rise sharply over that 6-year period, by £36.6bn, so that the actual cuts to services, benefits, pay and jobs will be £145bn, or 10.3% of GDP. By contrast, Thatcher’s annual debt interest payments fell, by today’s equivalent of £17bn, which we will examine below. So her real cuts to government spending therefore amounted to 4.7% of GDP or £66bn in current terms over 10 years. Osborne, Cameron, Clegg and Cable are planning cuts of £145bn or 10.3% of GDP over 6 years. This is more than twice the real cuts of the first Thacherites, and will feel even worse. No wonder the Financial Times believes the Budget is ‘risky’.

Further Lessons of Thatcherism

Tax cuts for business and the rich destroy any claim that the overriding priority is deficit-reduction. But history also demonstrates that cutting spending will not reduce the deficit. SEB has previously shown that Thatcher inherited a deficit of £8.75bn and produced average deficits of £9.00bn over the next 5 years. Similarly, the total debt level rose from £98bn to £157bn. The only reason that interest payments were finally lowered, was a result of the recovery later in the 1980s. Meanwhile, the deterioration in government finances during the first five years would have been much worse without the surge in government revenues from North Sea oil, which was an unforeseen bonanza.

In the chart below government revenues from North Sea oil are shown as a proportion of GDP, with Treasury forecasts for the next five years. An underlying measure of the government budget balance is also shown, which is the budget balance with the effects of the oil revenues removed. This underlying deficit initially rose under Thatcher, from 2.6% of GDP in the year before she took office to 2.8% and then 3.0% of GDP in the following 2 years. Surpluses were recorded in FYs 1982-84 before falling back into deficit once more. Throughout the entire period the economy generally and government finances in particular benefited from North Sea oil revenues, which were equivalent to 3.2% of GDP in the Financial Year (FY) 1984/85. This will not be repeated in this period.

Figure 1

10 06 26 SEB Budgeet Chart 1

Effects of Government Spending

Since government spending is both a component of GDP and a part forms a component of gross fixed capital formation (investment) in the national accounts, it is easy to see how reducing it depresses activity directly. But it also depresses private sector activity indirectly. This is because the output of all sectors of the economy requires the inputs of other sectors. Government output relies on the inputs of the private sector.

The table below is taken from the official analysis of the Input-Output tables from the ONS . The columns show the total output for each of the broad government sectors shown. These are always 1 because the purpose of the table is to show the relative impact on other sectors arising from 1 unit of output. So, £1bn of government output in education, healthcare and social work requires an input of £6mn in agriculture, £5mn in mining, £120mn in manufacturing and so on. It also requires £486mn in inputs from private firms operating in the same sector. The total demand of those other outputs and government output combined is £1.854bn, and 1.854 is the multiplier attached to this sector.

Table 1

10 06 26 SEB Budgeet Table 1

Osborne & co. hope that the private sector will fill the gap left by the decline of public expenditure by increasing its own output and investment. The scale of the government and their own impact is one factor which makes this very unlikely. With an average multiplier across the public sector just below 1.8, his cuts of £145bn will reduce demand by £260bn, over 18% of GDP. The total contribution to GDP from all production, construction and service sectors of the economy has amounted to just 3.5% over the last five years.

The policy of the Thatcherites, old and new, is to ‘crowd in’ private sector activity. Access to service is determined by profit-maximisation and is then a function of income or wealth and consequently both the scope of services declines and their prices rise. This is illustrated by the fact that the NHS is a universal system at a cost of 8.3% of GDP, whereas 45million Americans do not have health care coverage and yet it consumes 16.3% of GDP. But for the Thatcherites an important goal for themselves would be achieved. Profit can be extracted from an area which had previously been in the public sector.

The existence of these multipliers also explains why cuts do not narrow the deficit, as Thatcher showed and the Dublin government amongst others is currently proving . While increased government spending in education, health and social work leads to increased total demand 1.854 times greater than the initial output, decreased government spending leads to a reduction in total demand by the same multiple. And it is this lower level of output which both depresses tax revenues and pushes up welfare-related spending as unemployment and impoverishment rise. As SEB has pointed out previously , the long-standing Treasury estimates is that of every rise/fall in output 75% is registered as a change in government finances, 50% tax revenues and 25% change in government spending (Treasury, Public Finances and the Cycle, Treasury Economic Working Paper No.5, November 2008 ).

So, a £1bn fall in output leads to a £750mn deterioration in government finances. But we have already seen that, without an increase in private sector investment and output, a cut in government spending of £1bn will lead to a fall of £1.8bn in total demand. The damage to government finances arising from the total fall in demand is 75% of£1.8bn. This is £1.35bn. This damage is greater than the initial cut of £1bn and therefore widens the deficit.

The same process works in reverse. A £1bn investment by government leads to £1.8bn rise in total demand, and a £1.35bn improvement in government finances follows. This is a net return of £350mn which could be used for further investment or to erode the deficit.

Why Do They Do It?

The argument that government investment can restore both economic activity and narrow the deficit will not be unfamiliar to readers of SEB, and it is becoming a little less rare in the wider economic debate. But the question is posed, why would policymakers set out to damage the economy in this way? Further, why would a government that clearly represents the interests of business and the rich, more accurately the capitalist class as a whole, be willing to sacrifice large chunks of that class, many of whom will be bankrupted by these extraordinarily large cuts?

There isn’t space here to develop a rounded response to those questions. But the chart below illustrates the main theme. It is taken from the Bank of England’s latest Quarterly Bulletin and shows labour’s share of national income over time.

Chart 2

10 06 26 Chart 2

Labour’s share rises during recessions. This is not because pay or jobs increase- the opposite is the case. It is, as the Bank of England puts it, because the fall in labour income is less rapid than the fall in profits’ share of national income arising from the fall in output. It is the overriding aim of this government, even more than its predecessors, to ensure this trend is discontinued. It does this not by promoting growth as there is no guarantee that the profits’ share of national income will rise. Instead, it sets about an assault on the wages and social wages of all workers, and cuts taxes for businesses. By this means it can aid the resumption of the long-run trend rise in the profit share. This is what the new chief of the Office of Budget Responsibility and seasoned Thatcherite Alan Budd described as engineering a ‘crisis of capitalism which re-recreated a reserve army of labour and has allowed the capitalists to make high profits ever since’

Osborne said in his Budget Statement that reducing corporate tax rates to 24% would advertise that Britain was ‘Open for Business’. The advert is a Primark one. Dublin and Reykjavik have the two lowest corporate tax rates in the OECD, while the weighted average is 35%. It advertises that Britain will be a low-tax, low-wage, low-growth, low-skill and low-investment economy, and is a part of programme that will deter significant large-scale investment. As one commentator at the time described 1980s Thatcherism ‘Welcome to Slumsville’.

The duty to oppose such a policy both on the grounds of social justice and economic rationality is self-evident.

1 comment:

Paul Reissner said...

Just wanted to follow up on two key points from your very clear and informative article

“Why would a government that clearly represents the interests of business and the rich, more accurately the capitalist class as a whole, be willing to sacrifice large chunks of that class….?”

“It advertises that Britain will be a low-tax, low-wage, low-growth, low-skill and low-investment economy, and is a part of programme that will deter significant large-scale investment.”

Your question and conclusions above imply that opposition to the government’s long term plan for the British economy will not just be confined to the working class. Do you have a view on what divisions are already evident in the capitalist class and what political voices express this opposition?