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More squeeze to come

Stephanie Flanders | 14:27 UK time, Tuesday, 6 October 2009

We shouldn't forget to be surprised at . Six months ago, he didn't like to use the word "cut" either.

But that was then and this is now. On the substance of what the shadow chancellor proposed, let me make two macro observations - with the caveat that there's plenty we still don't know. I'll say more on the micro in a later post - particularly the promise to make savings of £3bn by the end of the Parliament on cutting Whitehall, which could be hard to fulfil.

George Osborne

The first macro point is on the scale of the package. Assume, for a moment, that Tory officials are right and it would raise about £7bn a year - half a per cent of GDP - by the end of the next parliament, or £23bn in total over that period.

The government's budget plans would cut borrowing by about 1% of GDP - roughly £14bn - a year over the next eight years. So, assuming that the Conservatives spend no more than Labour in other areas, you could say they are taking the government's squeeze and raising it by another half a percent of GDP a year.

If nothing else changed (which of course it will, but bear with me) that would mean the deficit was still high by historical standards by the end of the next Parliament.

Let's be clear: this is not the limit of the Conservatives' ambition with respect to budget cuts. We may or may not get details of the rest of the squeeze this side of the general election - but you can bet there will be more to come.

Point two relates to the timing. As I've been saying for some time, the big dividing line between the Conservatives and Labour over the budget is over when you start to cut borrowing. Labour says it's too risky to cut while the economy is still weak - the Tories say that borrowing is too high to risk delay.

I've been surprised how willing the Conservatives have been to confront this argument head-on. As I have argued in the past, there is a respectable economic case for saying that tighter policy will help the economy more than hurt it - by building confidence in the markets and delaying higher interest rates (I'm not saying it's right, but it's perfectly respectable).

The trouble, for the Tories, is that Labour have intuition on their side on this one. Most people assume, understandably, that lower public demand in the economy must mean slower growth overall.

But what's even more interesting is that, on the basis of the plans announced so far, this enormous chasm in rhetoric belies a very small difference in what they would do.

As the IFS has pointed out, Labour's plans are front-loaded - they're actually planning to withdraw 2% of GDP - around £25bn - from the economy in 2010-11 by withdrawing the stimulus. Whereas today's plan from Osborne is highly back-loaded.

That £7bn a year saving is by the end of the next parliament. So is the £3bn a year to be saved on cutting bureaucracy. And the public sector pay freeze - the biggest single saving, doesn't take effect until 2011.

By my reckoning, these measures taken alone would only cut borrowing by maybe £2bn, if that, in 2010-11. Or at most 0.2% of GDP.

As I've said, I firmly expect that the Conservatives would squeeze more than this if they won the next general election. But on the basis of what we know now, the big picture difference between them and Labour in 2010-11 is pretty small. It's a good point to bear in mind - as they now go to war over the fine print.

Comments

  • Comment number 1.

    At last, someone telling it like it is without any partisan inference.

  • Comment number 2.

    Having listened now to all our incompetent politicians at their puerile party conferences falling over each other to try and impress us how they'll gleefully cut public spending, what surety do we have that they'll be any more effective in the bad times than they were in the good times ? As if we didn't know. Britain is in a total, complete mess.

  • Comment number 3.

    The Tory plans, such as they are, do not take into account the impact of inflation, so far as I can see. Whereas the result of a Labour cut of a billion today, with a relatively predictable inflation rate is reasonably predictable, who is to say what this will be equivalent to in a decade's time (under the Tories) when inflation is relatively unpredictable. It may cost twice as much in numerical terms in a decade's time, or perhaps half as much with rampant inflation. In other words back loading loan repayment is accompanied by far more uncertainty.

    Further one of the the consequences of this Tory uncertainty is almost certainly going to be downward pressure on sterling, perhaps dramatic downward pressure. What price the 2 Pound Tory Euro anybody?

  • Comment number 4.

    WHAT'S IN THE DRAGON'S GROTTO?

    Stephanie, it might help if you provided a short article on what Britain now produces, what's shrinking and what is liely to grow or shrink in the future. It's all very well Cameron, Osborne and Clarke taking pot shots at 'schemers and dreamers', what we'd probably all like to see/hear is what Britain now produces, and what it's likely to produce in the future. What are all these businesses which the Conservatives say they're going to stimulate going to be and where is the money going to come from to 'stimulate' them now securitization has made all them so much more risky?

  • Comment number 5.

    I'd like to hear what the Conservatives have to say about fiscal policy. Presumably they have one, but I haven't seen the full text of his speech and this bit of the argument isn't getting reported. It seems strange to me that the debate is entirely about cuts in spending. What are the revenue assumptions of the two parties? Are we talking tax cuts as well as spending cuts? What is the assumed impact of years of low growth on revenue? Is there any consideration of raising tax rates, direct or indirect?

  • Comment number 6.

    The major thing that politicians don't mention in their economic plans is that the banks and financial institutions have become too powerful. The banks in particular should primarily serve the public and sharholders are always a secondary consideration. Without the public shareholders would suffer and after all the banks are using our hard earned cash to charge us. More the fools us!

    I have little hope that things will change.

  • Comment number 7.

    While there seems to be little difference in what is being proposed for cuts at least the Tories aren't proposing a whole range of unaffordable new policies such as personal care for the elderly.
    I would like to see it go further - 2yr pay freeze for the public sector and a much quicker hike in the retirement age for women - it's ridiculous that they get their pension 5yrs before men but are likely to live longer.
    There are more cuts to come from the Tories though - personally I respect their honesty with this speech and will vote for the party I feel is most honest and realistic with voters about the deficit. The Tories might be in a better position to do it though as they aren't at the mercy of the unions.

  • Comment number 8.

    As John_from_Hendon said the problem lies with unpredictability of inflation. There is a very serious risk with the Conservative proposals that they could be totally wrecked by inflation.

    What did Cameron promise the electorate about being honest and open about Tory policies?

  • Comment number 9.

    #3 John_from_Hendon. How can anyone take inflation into account? No-one knows whether we are facing inflation or deflation. No-one can know, in part because the government changed the law to enable banks to hide the true extent of their toxicity.

    This being the case no-one knows whether the money printing is occurring at a faster rate than the destruction of money/credit. If it is not then we get deflation.

    In the US you have already seen Walmart profits decline with their explanation being that of deflation. This in a country where Dr. Bernanke has assured the world that he is a great alchemist able to prevent deflation in all circumstances.

    This then is the background against which British politicians spout their own brand of garbage, and the British media dutifully reports every meaningless word.

    No-one knows what is going on because they have ensured that no-one can know what is going on. Then they expect you to vote for them. Who, in their right mind, would vote for any of these people?

  • Comment number 10.

    The problem is that although the economy is a total mess (and was out of balance long before the collapse), people have got so used to the notion of something for nothing.
    The adjustments necessary to get the public finances and trade figures back to anything like balance would be too much of a shock and people would vote to protect their own vested interests even though it would result in the long term collapse of the economy.

    The current mess is poisoned pill all the way, and it will take a long time for the mentality of "I deserve" to be changed, hence although bigger cuts are needed, politicians are face with only being able to do so many and remain electable.

    A complete shambles, which contrary to many claims, was not just foreseeable, it was inevitable, it was just a matter of when the chickens came home to roost.

  • Comment number 11.

    #9
    "No-one can know, in part because the government changed the law to enable banks to hide the true extent of their toxicity."

    Ahh yes all of those assets that the banks claimed not to be able to value.
    Strange that when things were going well they could value them and use them as capital.. and it was always possible to value these collateralised mortgage books, just value each mortgage in them and add them up - but the numbers would have been too low and forced the banks to take serious hits to their P&L, whilst further undermining capital and more significantly confidence. It was therefore considered better to hide the problem, allow confidence to return and get the asset bubbles reinflated.

    The Keynsian, throw money you don't have at the problem, approach was fortunate that although it didn't directly solve anything; people believing it might created confidence and stabilised speculative markets.
    Its more about psychology than traditional economics, which means expectations and mindset are actually more important to much of the economy than the key "levers", perhaps more focus needs to be placed on behavioural economics than the old failed models.
    Of course for the Keynsian approach to have a real positive long term effect on the economy, government borrowing should be used to support investment that builds for the future and repays that borrowing, instead of just supporting consumption.

    Keynes was certainly right on one thing; "in the long run we're all dead" hence the approach of spend now and try to shuffle the problems of paying for it on to future generations, a classic Keynsian approach.

    But even that can only go on for so long before you struggle to finance the borrowing and / or exchange rate movements mean you have to reduce imports.

    Living within our means may be a novel concept, but it seems fairer than crippling the economy by burdening our children with unsustainable debt.

  • Comment number 12.



    "Living within our means may be a novel concept, but it seems fairer than crippling the economy by burdening our children with unsustainable debt."


    One way or another every generation burdens its children. Debt is only the latest flavour. So stop being so whimpy get on with sorting the mess out as best we can and let the children have their way when they control the economy!

  • Comment number 13.

    #12 foredeckdave wrote:

    "stop being so whimpy get on with sorting the mess out "

    Whimpy? Hardly, I'm saying face up to reality deal with the fact we're spending more than we're earning and put our house in order.
    Not exactly "whimpy" - the "I want, I want, and the future can go to hell, its not my problem" approach seems much more selfish and "whimpy", expecting everything and not taking repsonsibility for anything

  • Comment number 14.

    Reaper_of_Souls (#13) Prediction: that will elicit a . It's interesting behaviour if you think about it.

  • Comment number 15.

    Remember all these cuts are attempts to realised the vast amounts of fictitious capital that have been built up.

    That is, to avoid capital devaluation, profits have been artifically maintained through asset price rises, e.g. stockmarket and housing bubbles.
    But all these 'clever' financial instruments rest upon the ability to extract value from the workers at some point in time, i.e. pay ever increasing amounts for a house, work longer (in hours per day & in years), paying more in taxes, etc.

    Ordinary people are struggling today.
    Squeezed even harder tomorrow there will eventually be a backlash (even if initially an ugly jingoistic one).

    And even if the Tories manage to resolve the fiscal blackhole (looking unlikely), the UK is very much exposed to the collapse of the US dollar (which although long predicted now seems on the horizon).

    For it is the US dollar that has been behind the huge growth in fictitious capital since the 1970's.
    The fictitious capital that has been recycled through the City of London.

    Bye, bye dollar, hello inflation.

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