We need cuts to liberate enterprise

Allister Heath
APART from the fact that they don’t go far enough, there were two problems with yesterday’s otherwise much needed and very welcome public spending cuts: first, they are not worth as much as the coalition claims, a shame given that we are meant to be entering a new age of openness, not continuing with Labour’s spin and statistical falsification. And second, George Osborne’s explanation of the need to reduce spending was insufficiently robust. He needs to redouble his efforts when trying to convince the public that belt-tightening is required: warning, as he did, that interest rates would go up without cuts is all good and well – but what will voters say when the Bank of England does eventually put up the cost of borrowing to stem inflation?

He also needs to explain that the size of the state is too large and the private sector needs to be given room to grow. We need a positive, pro-growth and pro-private sector rhetoric from the chancellor; he needs to go further in addressing and demolishing the intellectually bankrupt, pseudo-Keynesian arguments cited by those who want to delay cuts for ever.

First, the details. Of the £6.2bn headline cut to public spending in the current year announced by Osborne, £500m is being recycled into additional spending or tax cuts, and the £704m earmarked for devolved administrations does not have to be found until next year. So, as the Institute for Fiscal Studies (IFS) calculates, the cut in borrowing in 2010-11 is just £5bn. This is less than a tenth (at best) of what will be needed over the next few years.

The coalition is keeping to Labour's planned increases in spending in the NHS, MoD and overseas aid (a clear mistake, in my view, at a time such as this). They have also decided not to cut spending on schools and education for 16-19 year olds. We will get new spending plans for each department in the Budget on 22 June. The IFS’s estimate of plans for each department suggest that the areas of spending that have not been protected will see their budgets fall by 8.4 per cent. The big problem is social security, which gobbles up a huge chunk of public spending: radical reforms will be needed to reduce claimant numbers by moving some of the near 6m adults on out of work benefits into employment. But that will take time, hence why other spending is being cut.

As the moment, GDP growth is expected to be subdued despite a massive injection of borrowed money by the government. This baffles Keynesian economists but makes perfect sense to those who understand that excessively bloated governments and triple-digit budget deficits have a contractionary, rather than expansionary, effect. This is because the private sector is being crowded out and has become too small to power a strong recovery; private capital, instead of being tapped to finance productivity enhancing investment, is being siphoned into gilts where it is going towards paying for current state spending. At present, the UK’s combined 2010 and 2011 growth is expected to come in at 3.6 per cent, private sector economists believe. This can be compared to growth in the first two full years of recovery after the early 1990s recession of 6.5 per cent, as Richard Jeffrey of Cazenove Capital points out. One big difference in those days was that we had a smaller state and far less over-spending. That is a lesson that the government needs to communicate much more forcibly.