The coalition must press reset and make a positive case for austerity

 
Patrick Nolan
GEORGE Osborne’s fiscal strategy increasingly resembles alphabet soup: Plan A for austerity, Plan A+ for magic bullets, Plan B for debt and Plan I for infrastructure. Flexible planning is not necessarily a bad thing. What is a problem, however, is if revisions do not reflect changing economic circumstances but a weakness in the Treasury’s approach.

On one level, the chancellor’s fiscal strategy has delivered. Ed Balls is wrong to say that our current situation means an earlier increase in spending would have been the right strategy. The Treasury got the big call broadly right. The pace and depth of consolidation brought market confidence. But it did little more than this, with Osborne planning a structural budget deficit of 1.5 per cent of GDP for 2014-15, compared to Alistair Darling’s pre-election plan of 1.3 per cent. Nonetheless, the country does have breathing space. This market credibility has been reinforced by Britain being outside the Eurozone.

But in other ways the Treasury’s approach has been a disappointment. At Reform, economists and business people are increasingly telling us of their concern over the lack of a supply-side agenda. And their concerns go deeper. There are also worries that the government is failing in its efforts to rescue the public finances.

These budgetary problems are not just caused by drag from the Eurozone. Major departments have failed to make promised savings. Indeed, most experts predict that the largest departmental budget, the NHS, will receive a cash boost before the election. On the revenue side, the coalition’s tax policy has increased complexity. By introducing high and variable rates, the coalition has increased incentives for tax avoidance. Sensible efforts to broaden the base, including VAT, have ended with embarrassing climb downs.

For long-time watchers of public finances these problems will not have come as a surprise. As early as June 2010, Reform was warning that the Treasury’s approach had real limitations.

One concern was a lack of realism. The coalition underestimated how hard fiscal consolidation can be. Ministers took their eyes off the ball and spent too much time on other projects, like reform of the House of Lords. They also tried to move on before the job was finished. They must recognise there is much more work to be done.

Another concern was a lack of consistency. Major spending areas were ring-fenced, including the NHS and pensioner benefits. This meant these areas had fewer incentives to do more with less, cuts in other areas had to be deeper than otherwise and lobby groups were encouraged to argue for extending special treatment.

Fiscal consolidation has also been poorly implemented. Even when the coalition set out to do the right thing, it failed to do it in the right way. An obvious example of this is the targeting of child benefit, which was so poorly implemented that the whole idea of means-testing has been damaged.

The Prime Minister appears to recognise some of these concerns. Last week he noted that austerity should be expected to last until 2020. But this should not be seen as an admission of defeat. It is a cliché, but fiscal consolidation presents opportunities as well as challenges. Rescuing the public finances can help build a stronger economy. This is certainly the experience of countries like New Zealand, which went through major reforms in the 1980s and 1990s. There is no doubt about how hard this decade of reform was, but the changes made have proven resilient.

Rather than alphabet soup, the economy needs greater clarity from the coalition. This requires honesty about the changes that must take place. Austerity is the new normal. Trying to prop up growth in the short term will simply postpone the inevitable.

This also requires the coalition to press the political reset button with a spending review now, not in 2014 or after the next election. This spending review must learn from the mistakes of the last. Rather than being an opportunity to develop a list of cuts, this should be seen as an opportunity to have an honest debate on how to curb the over-reach of the state.

Dr Patrick Nolan is the chief economist at the independent think tank Reform.