Oct 11th 2022, 18:54
Blog - 11th October 2022
In this blog I consider the recent ‘mini-budget’ and what it means for public services.
The radical changes to economic and fiscal policy announced by Kwazi Kwarteng, the Chancellor of the Exchequer, in his budget in September were an admission by the government that the economy is in serious trouble. Exports are down, investment is down, the pound is plummeting, inflation is increasing, poverty is increasing and there is no economic growth.
The government’s solution is to introduce massive subsidies for business and massive tax reductions for the wealthy and to fund these through borrowing. Many people have criticised this approach for failing to focus support on the poorest people during the cost of living crisis. However, the government’s argument is that these measures will create economic growth.
The Jarrow March took place in 1936 during the great depression
Britain, though, is not in the sort of recession that happened in the 1930s when low levels of demand caused the economy to operate below full capacity leading to widespread unemployment. In that situation, the famous economist Keynes identified the solution as being for the government to create more demand by cutting taxes and / or increasing expenditure. This would ‘kick start’ the economy and encourage increased consumer spending and investment until the economy operated at full capacity with full employment.
The problem today, though, is that low levels of investment have caused low levels of productivity, meaning that the economy is contracting despite there being high levels of employment. With low productivity and high employment the economy doesn’t have the capacity to grow in the short-term so the borrowing and tax cuts will simply stoke inflation. Also, the reduced value of sterling will not benefit exporters as it usually would because of Brexit bureaucracy, low productivity and the lack of capacity to expand.
What we need in the long-term is more investment and the government argues that this will not happen unless there are big tax cuts for businesses and the wealthy. However, levels of investment in France (for example) are higher than in Britain, despite Britain already having lower taxes. This is explained by France being part of the European single market. If Britain isn’t part of that market it needs to do something else to encourage investment, hence the tax cuts.
This has been part of Brexit economics all along. Inside the European Union, countries have a social market economy like Britain with minimum standards for workers’ rights, consumer protection and the environment. Outside the European Union, ‘global Britain’ can cut its standards, costs and taxes and become more like those countries that the Brexiters much admire – the BRICs countries – Brazil, Russia, India & China – that have higher economic growth combined with great inequality, great poverty, low standards and no meaningful welfare state.
But there are few economists who believe the ‘Brexit’ gamble will pay off. Economic forecasts by the investment bank Citigroup that the Institute for Fiscal Studies uses to underpin its analysis show that the UK will struggle to grow at more than 0.8% on average over the next five years compared with the government’s 2.5% growth target - itself pitifully small compared with forecast growth rates in the United States and European Union.
Then there is the problem of public debt that is already at a record high. The Institute of Fiscal Studies calculate that the £45billion cost of the mini-budget will wipe out any financial space left to the Chancellor by his predecessor, swelling Britain’s debt as a share of national income for at least the next five years. As Paul Johnson of the Institute for Fiscal Studies said:
“The Chancellor announced the biggest package of tax cuts in fifty years without even a semblance of an effort to make the public finance numbers add up. Instead, the plan seems to be to borrow large sums at increasingly expensive rates (and) put government debt on an unsustainable rising path.”
The government knows this, and that is probably why they suppressed the economic reports prepared by the Office for Budgetary Responsibility. This means that our public services and welfare state are no longer funded by taxation but are funded instead by unsustainable borrowing.
What they didn’t expect (although they would have done if they had listened to advice) was the extent of the adverse reaction in the money markets that caused sterling to lose value, the cost of government debt to increase and pension funds to fear for their viability. The Bank of England was forced to step in to spend heavily on government bonds to protect sterling, the government’s credit rating and pension fund viability – all requiring additional borrowing. This support package is planned to come to an end on Friday but there is every possibility that it will need to be extended at even greater cost.
This week the Institute for Fiscal Studies reported that the government will need to find £60billion of savings by 2026 to fill the gap left by unfunded tax cuts and the costs of extra borrowing, despite the fact that public sector spending has already suffered a huge hit over the last decade and that there was ‘not much fat left to cut’.
In one scenario, modelled by the Institute for Fiscal Studies, the government could retain the tax cuts if they: indexed working age benefits to earnings and not inflation, reducing the uplift to about 5% from 10%, to save £13billion; reduced public investment by a third to 2% to save £14billion; and returned to austerity across most Whitehall departments – excluding health and defence – to save £35billion. While this scenario would protect the National Health Service and defence budgets from inflation, it would not provide the health sector with any budgets to cope with higher demand and backlogs and would not enable the Prime Minister to increase defence spending from 2% of GDP to 3%.
A reduction of a third in an already inadequate affordable housing programme would make it impossible for councils and housing associations to meet the increasing need for new homes. The number of homeless people and people housed inadequately would increase significantly.
Brixton Town Hall where Lambeth Borough Council is based
Local government will face a triple whammy of increased demand for services, increased costs (including interest rates) and reduced funding. Councils are already beginning to worry about their financial viability. The prospect of economies on this scale has not pleased anyone in local government. For example, Councillor James Jamieson (Central Bedfordshire, Conservative), the Chair of the Local Government Association, pointed out that councils had already implemented £15billion of economies between 2010 and 2020 and added that:
“The government needs to ensure councils have the funding to meet ongoing pressures and protect the services that will be vital to achieve its ambitions for growth and to produce a more balanced economy, level up communities and help residents through this cost-of-living crisis. Without certainty of adequate funding for next year and beyond, and given the funding gaps they are seeing, councils will have no choice but to implement significant cuts to services including to those for the most vulnerable in our societies.”
But this is only the beginning. In 2026 the government is likely to still be borrowing £100billion a year when previous forecasts showed it falling to nearer £30billion. This is clearly not sustainable. When the government reaches the end of the road and can borrow no more the National Health Service, schools, social care, pensions, benefits, social housing, the police and all our other public services will find themselves unfunded and will have to be largely closed down. Unless there is a change of course soon, Britain will become a third world country.
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