Why Osborne has targeted the wrong kind of spending cuts

HERE is the truth about the cuts so far, courtesy of the Office for Budget Responsibility (OBR). The deficit is down by about a quarter from its peak over the past two years, though it has increased again since the start of the current fiscal year. Looking just at 2010-11 and 2011-12, two thirds of the fall in the deficit reflect lower public spending and one third tax hikes. The deficit was 11.2 per cent of GDP in 2009-10, 9.6 per cent in 2010-11 and 7.8 per cent in 2011-12, though the latest data show that the deficit is increasing again.

Capital spending has fallen by 1.8 per cent of GDP and current spending by a much less than commonly understood 0.6 per cent of GDP, a poor mix which is clearly a mistake. Within current spending, debt interest is up 0.9 per cent of GDP though this has been offset by a 1.4 per cent of GDP fall in other current spending. Tax receipts have jumped 1.1 per cent of GDP, entirely accounted for by higher VAT; there has been a slight fall in income tax as a share of GDP reflecting weak self-assessment receipts and the substantial rises in the personal allowance.

As to the reasons why the economy has under-performed so much, the OBR highlights falling real wages – hopefully a trend that will abate, with retail price inflation falling to 2.6 per cent last month and consumer price inflation to 2.2 per cent – and weak export markets. It was careful not to state that austerity had proceeded too fast or to endorse the ultra-Keynesian claims made by the IMF last week.

To this perfectly reasonable analysis I would add that the mix of cuts and tax hikes was wrong: it would have been better to rely less on tax hikes and more on cuts to current spending. In order of importance, the reduced deficit comes from less capex (the one category of public spending that can boost growth if it isn’t wasted); then tax (which damages growth, though VAT less so than direct tax); and only then current spending, which remains far too high as a share of GDP.

That is one of the problems with George Osborne’s austerity plan (it was also shared by his Labour predecessor Alistair Darling’s): the easy cuts – capex – are always made first, with the harder ones pushed back indefinitely. Yet long-run that makes the job of reducing the budget deficit even harder: the wrong kind of austerity ends up hitting growth and making the adjustment process even more painful.

COMPENSATE THE LOSERS
London’s Supersewer is a vital piece of infrastructure, a 24 mile tunnel that will prevent sewage from ending up in the Thames and bolster our capital’s antiquated Victorian system. It is officially called the Thames Tideway Project and is due to start construction in 2015. But it is becoming clear that the human cost of the project will be very high, with hundreds of homes blighted by extreme noise and other problems for lengthy periods. The answer is not to ditch the project but to compensate the losers properly. The expected cost of the project is some £4.1bn – so generously paying off those affected, and in some cases buying their homes at a premium to market price (and reselling them when the work is finished) would hardly make much of a difference. It would be better to spend £4.2bn, protect affected individuals and speed up the planning process rather than risk the entire project descending into endless controversy.

In general, the UK needs to adopt a far more generous compensation regime for the losers in infrastructure projects. It is the only way to prevent nimbyism defeating all progress while protecting individual rights.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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