Thursday, 21 October 2010

Comprehensive Spending Review Turns Screw Even Tighter

By Michael Burke

The headline totals for spending cuts announced in the Comprehensive Spending Review (CSR) are broadly in line with the ferocious assault on the welfare state as outlined in the June Budget. However, beneath those headline totals there is a further shift away from any spending which provides services or benefits the poor as well as clear evidence that virtually all areas of spending will see excruciating cuts in real terms. The one important exception to this is military spending which, despite claims to the contrary, will probably not experience any real decline at all.

Real Spending Cuts

As the last Tory government began to fracture hard-right keepers of the Thatcherite flame emerged who were too extreme even for John Major’s government. One of those was John Redwood who has recently been pedalling the notion that, because nominal (cash) spending is projected to rise over the course of this Parliament, there are no cuts in spending at all. A measure of how far the ideological terrain has shifted is that this nonsense is parroted by the BBC, especially its economics editor Stephanie Flanders.

George Osborne toyed with this idea too in his speech presenting the Comprehensive Spending Review (CSR). But this notion is demolished by the details of the CSR itself , which shows that virtually every department suffers a cut in real terms, after inflation (Tables A5 and A6 of the review). So, the Chancellor boasted in the section of his speech on education that spending per pupil would be maintained. But this is not true. Real current spending is said to fall by 3.4% in the period to Financial Year (FY) 2014/15, while investment or capital spending will fall by an outrageous 60%. Further, with pupil rolls increasing over the period, the cut in real spending per pupil will be even greater, by over 10%.

Similarly, the Chancellor boasted that NHS spending would rise by £10bn. But an implicit rate of inflation over this period (Table A5) of 9.8% wipes out this nominal rise in real terms. Further, as Osborne acknowledged, the population is ageing (as well as growing), so that real spending per person will decline by around 10%.

These are the areas where the Coalition boasts it has protected spending. In addition, the projected 9.8% cumulative price rise is likely to be highly flattering. The Office of Budget Responsibility has made a series of inflation projections for the same period (Budget Redbook, Table C5) with a range from 13% to 18.4%. The real falls in spending are set to be larger than stated in the CSR, perhaps massively larger.

Winners And Losers

Health and education are areas where the Coalition falsely claims to have preserved spending. The other is International Development, but SEB has already shown to be not about genuine aid at all .

By contrast, the Chancellor was happy to boast that there will be a further £7bn in welfare spending cuts, in addition to the £11bn in cuts made in June. To paraphrase the BBC’s Nick Robinson, this means that 18million households will be £1,000 worse off each year. This is a brutal assault on the incomes of workers and the poor. It will be supplemented by an £11.4bn cut in the cash budget for communities and local government. To give just one example, this will include a 25% reduction in the central government grant for local authorities’ spending on the fire service. This is a wholesale assault on the welfare state and basic services.

Yet not all areas of spending will suffer cuts. SEB has previously argued that military spending was being sheltered by the government, and the CSR clarifies the extent of that. Total military spending is set to rise to £36.9bn from £35.7bn (Table 2.13). It is stated that this is a real fall in spending. However, the Chancellor was explicit; the financial commitment to maintaining the occupation of Afghanistan will be a separate item, funded from reserves.

Crucially, these reserves are set to rise over the period. In fact, there is an entirely new category of spending. In addition to the usual ‘Reserve’ heading, there is also now a ‘Special Reserve’, which will total £15.5bn over 5 years (Table 1). Since no other category of spending has been pre-allocated to this area it is reasonable to assume that the bulk of it is destined to fund the war in Afghanistan. This represents a real increase in military spending, not a cut.

The Economic Consequences of Mr Osborne

The economic impact of these cuts will be severe. The latest IMF research suggests that the negative effects of government spending cuts are magnified when other countries are also engaged in cutting spending, or when there is little scope to cut interest rates further. Since both these conditions apply currently, the IMF estimate of the impact of spending cuts is doubled in the first year alone. That is, every £1bn cut in government spending leads to a £2bn decline in economic activity in the first year. Worse, as there is a long-term negative effect, the cumulative effect after 5 years is a £6bn decline in GDP arising from a £1bn cut in government spending.

These effects are shown in the charts below, with Canada used as an example because it is an open, mid-sized industrialised economy (‘open’ to the rest of the world economy via imports and exports).


Chart 1. Impact of a 1% GDP Fiscal Contraction

10 10 21 SEB CSR


On this basis, £9bn in discretionary spending cuts this year will lower growth by £18bn next year and by £54bn in 2015/2016. The effects of the £81bn cuts due by the end of this Parliament are proportionately magnified over time.

Any cut which reduces output by a factor of six will of course have a negative impact on government finances. It is inconceivable that the deficit could seriously narrow as a result of this policy.

The social consequences will be equally grave. Literally millions of people will be driven into poverty. The new British-based winner of the Nobel Prize for Economics Christopher Pissarides says he would be ‘very concerned if social benefits are targeted. This risk is that people will sink into poverty’. The effect of raising the retirement age to 66 will exacerbate this trend, with women hit particularly hard and youth unemployed increased further. As Pissarides, Blanchflower and others have shown, early-life unemployment increases the risks of both long-term unemployment and sporadic employment throughout a whole working life.

Not just the government but Labour politicians too need to abandon any notion that welfare cuts are some sort of populist, cost-free means of cutting the deficit. The poor also pay taxes, and tend to spend the entirety of their incomes (often more than their incomes). Cutting those incomes will not only be devastating for them, but for all the businesses, jobs and taxes their spending generates.

Ideological Cover

All of this is done in the name of promoting the private sector at the expense of the public sector, but this completely ignores the real relationship between the two. The public sector is the private sector’s biggest single customer. Cutting the public sector’s spending, and laying off a projected 490,000 workers will destroy large parts of private sector activity, through lost orders, employment and spending.

The notion that the private sector is straining at the leash is also a fallacy - its refusal to invest accounts for 70% of the British recession. Reduced demand from the State is a further deterrent to private investment. So too is the government’s own 29% reduction in its investment (CSR Table 6), which is before inflation and depreciation are taken into account.

Nor is it the case that the private sector can deliver services more efficiently, even if government were simply switching the source of its services, rather than making outright cuts. This FT survey of public sector versus private sector provision in areas such as prisons, welfare-to-work and healthcare shows that the private sector is not a more efficient provider of services . On the contrary, governments, including Labour governments have been often willing to provide additional revenues to both private and ‘third sector’ (private, non-profit organisations), only to find the service provided is the same or inferior.

Conclusion

The Tory led coalition has fulfilled its threat to launch a ferocious assault on the living standards of the majority of society. Children will be making a greater contribution than the banks for a crisis in which the latter played a leading role. Welfare recipients are being driven into poverty in a vain effort to fund continuing Britain’s imperial role.

Clearly, this policy will cause widespread misery and anger. Many will attempt to divert that towards recipients of welfare, when their spending is a necessary component of economic recovery. There will also be attempts to scapegoat minorities, especially Muslims, black people and Eastern European migrants. But the essential truth is that this crisis is one of private capitalism as a system, which could be overcome by the State increasingly directing investment where the private sector remains on an investment strike. The cuts policy will not close the deficit, as many European economies currently demonstrate and as the policy starts to unravel the hunt for scapegoats will only increase. All the inevitable anger at these measures needs to be educated, organised and channelled against the real culprits.

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