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Deficit Reduction: Keeping Ahead of the Curve in 2012

    In the first of the CPS' 'UK Policy Resolutions for 2012' series, CPS Advisory Council member Lord Flight details the need to stay ahead of the curve on deficit reduction. To read the continuing overview of the series published earlier, click here

    UK Policy Resolutions for 2012: 

    • Propose further cuts to public expenditure to stay ahead of the curve on deficit reduction
    • Eliminate the public sector wage premium
    • A review of welfare expenditure
    • A full cost-benefit analysis of EU membership

    The Office for Budget Responsibility’s reduced growth forecasts mean that George Osborne has rolled forward his plans for eliminating the fiscal deficit by 2015, and that an additional £111bn of borrowing will be required.

    So far this has not dented the UK’s credit worthiness – markets have far too much to worry about in the Eurozone.  My advice to the Chancellor is, however, to stick to his original 2015 date and to identify further spending cuts to be able to achieve this.

    Not only is our favourable credit rating fundamental to our financial stability and saves £20bn funding costs; but, as witnessed in the Eurozone, any “wobble” in our perceived credit worthiness could easily escalate into a major crisis and increase in funding costs.  Our continuing credit worthiness reflects in part having our own currency and our own Central Bank which can buy government debt via Quantitative Easing.  But the crucial issue is the belief that the Coalition has credible plans to manage the public finance into balance. 

    The reality is that our combined public and private debt problems are worse than some Eurozone economies.

    Public sector spending is continuing to rise in cash terms, and as many fail to appreciate, the combined additional borrowing requirement between now and 2015 is £350bn and will increase our debt as a per cent of GDP to 78%.

    There is, I suggest, the risk that if there is a break-up of the Euro, subsequent to this, markets will take a less favourable view of Britain’s position, where our economy and growth will anyway suffer if the break up is chaotic.

    I therefore advise the Coalition that it would be wise to be “ahead of the curve” so that there is a much better probability of retaining our credit worthiness whatever happens to the Eurozone.  It strikes me that our position is far from secure if, having already rolled forward the plans for eliminating the fiscal deficit beyond 2015, these have to be rolled forward further as a result of the Eurozone problems.  The roll forward cushion should be reserved as an insurance against the knock on effects on UK growth which might result from a disorderly break-up of the Euro.  The risk – even if modest – or getting caught with spiralling, debt financing costs, is just not worth running.

     

    UK POLICY RESOLUTION IN 2012

    I suggest there is no meaningful scope to increase taxation – rather there are strong supply side arguments for reducing taxation where this is possible on “Laffer curve” grounds.  The only option is to identify the areas in which public spending – currently running well ahead of 50% of GDP – could be cut further.  Here I point to Ireland’s example.  While the Chancellor is rightly looking to abolish national pay deals for the public sector and to cap pay rises of 1%, there is a strong argument for cutting public sector pay.  It has for long been accepted that it is fair and economically appropriate for public sector remuneration – level by level – to be a few percentage points below private sector pay, reflecting shorter hours worked in the public sector, better security of employment and very substantially better pension arrangements. 

    The “hosing” of money at the public sector by Gordon Brown, combined with agreeing very generous pay deals with the public sector Unions have led to a position where public sector pay, level by level, is around 10% above private sector pay, without allowing for the value of public sector pensions.  Moreover, many in the private sector are facing being obliged to agree pay reductions if they are to keep their jobs.  A significant proportion of total public spending is represented by pay and this, therefore, an area where a 5% pay reduction, across the board, would achieve substantial savings.

    The second area where there is scope to achieve savings is welfare expenditure – not for those in real need - but where, for example, the UK has become a haven for migrants from all over the world because of its generous welfare arrangements.

    After including the various accounting “fiddles” e.g. treating tax credits as a reduction from tax revenues rather than expenditure, and including welfare expenditure hidden in regional expenditure, welfare spending, excluding state pensions, is now running at around £160bn p.a.  This is a total which the country cannot afford.  What is needed is far greater investigation of areas where welfare entitlements are abused.  

    Thirdly, there is the need for a much sharper cost benefit analysis of EU membership, the costs of which have risen dramatically over the past few years.

    The cuts which would be required to stay on course for eliminating the deficit by 2015 are not as dramatic as they might sound – in aggregate, an average of around £30bn p.a.  We would be much better placed to be identifying these cuts now, rather than risk finding ourselves in a position where much larger cuts were forced on us if we were to lose our credit worthiness.

     

    Lord Flight is a Conservative member of the House of Lords and the former MP for Arundel and South Downs. He served as Shadow Chief Secretary to the Treasury under David Cameron and is a member of the Centre for Policy Studies Advisory Council. In 2011, he authored ‘The End Game for the Eurozone’ for the CPS.

    This article represents the views of the author only and does not necessarily represent the policy outlook of the Centre for Policy Studies, its board, staff or affiliated members.

    The second article in the series, from Dr. Tim Morgan of Tullett Prebon on managing prolonged periods of austerity, will be published tomorrow morning. 

    Lord Flight has worked in the financial services industry since the 1970s, starting at Rothschilds, before joining HSBC. He moved to Guinness Mahon in 1979 where he established the Fund management business which became Guinness Flight Asset Management in 1986.

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