Public spending still over half of GDP

Allister Heath
ED Miliband should be happy: Britain officially remains a state-dominated economy. For all the talk of “swingeing” cuts, public spending is set to remain at 50.1 per cent of GDP in 2011, according to the latest OECD predictions. This is an astonishing figure: more than half the economy, which by one definition means that the UK is more socialist than it is capitalist.

In fact, this is the third year in a row that state spending will be worth more than half of national income: it was 51 per cent last year and 51.2 per cent in 2009. Britain is one of just eight OECD countries out of 32 to be saddled with public spending worth over half the output of their economy. Spending is set to drop to 48.8 per cent of GDP in 2012 but even that relatively small reduction could be derailed if the economy continues to slow.

There are many who believe that spending cuts (or the fear of future cuts) is dragging down growth. My contention is the opposite: because the state still dominates the economy so much, and is being reduced at such a snail’s pace, the positive, expansionary supply-side effects from downsizing the scale of government have yet to manifest themselves. At this rate, they will actually take years to kick in, which is George Osborne’s big problem. There is plenty of economic research which shows that large, bloated governments drag down growth and that downsizing them boosts growth; but nobody would argue that this applies when trimming government spending almost imperceptibly, as the OECD stats suggest is the case in the UK.

That is the biggest structural reason why the UK economy is stuck in the slow lane. There are of course other shorter-term reasons which explain why independent economists have cut their growth forecast for this year to 1.3 per cent, according to the monthly poll compiled by the Treasury yesterday. One hugely important reason is the fear of a spillover from the Eurozone and US debt crises. Citigroup, for one, has just downgraded forecasts for the US, Japan and the Eurozone, as well as the UK.

Another hugely important reason is that take-home pay has been falling as a result of high consumer price inflation, surging costs and taxes and low wage growth. The Asda Income Tracker produced by the Centre for Economics and Business Research shows that wage growth has lagged inflation since early 2009. There was a £9 a week (five per cent) fall in family spending power compared with last year in July. The average UK household had £167 a week of discretionary income in June 2011 – the lowest level since January 2009, the CEBR research suggests. Discretionary income has fallen for the last 18 months and looks set to decline into next year. The problems include soaring utility costs – caused in part by Britain and Europe’s stringent environmental laws, which are pushing up the price of energy – as well as high petrol costs – partly due to ultra-high taxes and also to the high price of oil – and higher food prices. The biggest single structural change is the 25 per cent devaluation of sterling, which is pushing up import prices.

So no wonder the picture is looking bleaker than it did earlier this year. The only real question now is whether we will continue to see sluggish growth over the next few quarters – or whether a sovereign debt crisis in the Eurozone or even the US leads to something much worse.
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