Dated: 3 December 2010
In the wake of the Irish financial crisis it has become even more important for the Chancellor to hold firm with the Spending Review, says the Institute of Directors (IoD) in a new paper entitled Don’t Go Wobbly, George. Financial markets are in volatile mood and any indication of retreat from the Spending Review will be pounced upon.
Potential ‘wobble’ moments on the horizon:
- We need to recognise that opposition to the Spending Review is likely to strengthen in the short term, with Whitehall inertia and lobbying from within the public sector testing the Chancellor’s ability to implement his spending plans.
- There is also a growing danger that if part of the Coalition is already wobbling on a politically sensitive issue like university tuition fees it might wobble even more on what is a much bigger fiscal issue, not least because political opposition to deficit reduction has yet to reach fever pitch.
Key reasons why the Chancellor must hold firm in the face of growing opposition:
- The risk of a spike in Gilt yields. Whilst the UK fiscal situation is very different to that in Greece and Ireland, the lesson of recent years is that financial panics can develop rapidly. The last thing the UK economy needs at present is a spike in gilt yields with negative knock-on effects on business investment and the mortgage market. Any spike would also undermine quantitative easing: a key QE transmission mechanism is asset purchases pushing up gilt prices and lowering yields.
- The spending squeeze is not as radical as opponents claim. Public spending is only projected to fall to 40 per cent of GDP at the end of the Spending Review – hardly a small state. The level of public spending in many parts of the UK (Northern Ireland, Scotland, Wales and North East) is closer to North Korea than South Korea. Such rates appear unsustainable if the UK is to maintain its competitiveness in the 21st century.
- In aggregate, the Spending Review is tender, not tough. Over the course of the Review (2011-12 to 2014-15) total managed expenditure (TME) increases by £40bn in nominal terms. Between 2010-11 and 2015-16 nominal TME increases by £90bn. In real terms TME falls by just 0.6 per cent per annum over the Spending Review.
- Public sector headcount reductions are entirely reasonable. They will take public sector employment back to the levels seen in the early/mid ‘noughties’. Private sector employment growth is perfectly capable of absorbing the projected decline in public sector employment. A 1 per cent change in private sector employment is equivalent to nearly 0.25 million jobs – not far short of the OBR’s projected employment cut in the public sector.
- Public sector productivity improvement would be undermined. There needs to be a relentless drive for ongoing productivity improvement. Official statistics show that public sector productivity declined by 0.3 per cent per annum over the 1997-2008 period, whilst private sector productivity rose by 2.3 per cent per annum over the same period. A wobble on the Spending Review is likely to remove the public sector’s incentive to improve productivity.
Commenting on the challenge facing the Chancellor, Graeme Leach, Chief Economist at the IoD, said:
“As the political heat rises over the next few months, we urge George Osborne to hold firm on the Spending Review. If any part of the Coalition shows even a slight loss of nerve, holders of government debt could lose their shirts. The last thing the UK economy needs at present is a spike in gilt yields with negative knock-on effects on business investment and the mortgage market.
“There is also a real risk that unless we regain control of public spending now, we could lose it for a generation, as the rising costs of an ageing population add further upward pressure for tax and spend policies. Political pressure to change course over the next few months must be resisted by the Chancellor. The long term future of the UK economy is at risk if the Coalition scales back the Spending Review.”
To read the paper click on: Don’t Go Wobbly, George
