Monday, 11 March 2013

Two Fairy Tales for the Economy - Plan A and B

Like the little Dutch boy David Cameron has his 'finger in dyke' of the coalition's economic policy.  Having set a course in 2010 to deal with the deficit through government spending cuts, supported by a monetary easing, there is now a flood of alternative advice coming from all quarters!

Britain's economic plight in 2010 was particularly bad as we had a fiscal deficit amounting to nearly 10% of our GDP annual, the highest of any major economy.  This was caused by  the emergence of a 'structural' deficit, which amounted to 6% of our GDP (lost receipts associated with financial services and associated sectors) added to the deficit caused by the general economic downturn, which amounted to a further 3%  of GDP.  When international benchmarks tell us that any deficit over 3% is unsustainable to be 200% over this was pretty dire.

The government responded by pushing through an austerity package that has 'reduced' government spending by £67 billion.  We are still only 40% through this programme, which has been extended out to 2018 - well into the next Parliament. It was hoped that reductions in government spending would be off-set but the private sector growth and this has been successful in part.  Many new jobs have been created, but continued spending on welfare, health and interest on the debt have meant that the deficit is still way too high.

Unfortunately the deficit is not the only issue.  There exists in the UK  high levels of personal debt, which is linked to a very high levels of private house ownership.  Our ability to apy down this debt has been hindered by drop in household incomes caused by private sector wage freezes and inflation in energy and food costs.  So our problems are two fold.  The state is too big and expensive and the private sector is burdened with falling disposable incomes.

The challenge is to try to get the economy growing and specifically the private sector.  And there are three options - Keep calm and carry on (Plan A), increase government borrowing to finance growth (Plan B) or increase the rate of austerity whilst giving tax breaks to generate consumer demand (Plan C).  In greater detail -

Plan A - The Governments plan
Stick with the austerity, which is planned to become more intense over the next two years and use quantitative easing (government buying up assets from the banks - mostly Government Bonds) to increase the availability of credit in the system.  According to David Cameron this is the only way forward.

Plan B - Promoted by Labour and other supply-side commentators
Ease back on the austerity and lengthen the time it takes to pay down the deficit.  Increase government spending on capital projects to kick start the economy and have a more active industrial policy- build roads, schools etc and fund apprenticeships.

Plan C - The one no one talks about
Accelerate government spending cuts and use some of this slack to cut taxes to raise real incomes and generate consumer spending and economic growth.

Of these options I think plan A is the least likely to work - everything is too tight, the government has to create slack to promote growth. so that leaves B and C.  The Keynesian approach set out in B is now a bit dated no one really believes that government officials are capable of conjuring up growth that has any long term benefits.  So I think its got to be Plan C.  We need to aggressively cut down the size of our state and this means all the state, including: Welfare and Pensions, Health (NHS) , Defence and Education. And in return we should give direct help to increasing disposable incomes, which will drive economic activity.  To do this we should reduce VAT (sales tax). Specifically the general rate of VAT should be reduced from 20% to 15% and we should zero rate VAT in sectors where we want to generate business growth - like building work on brown field sites.

We must turn our attention (although its hard to do) from the economically inactive (the unemployed, the ill, the old and the lazy) and focus on giving people in work a boost.  So to end on another fair story - by heaping most of the pain of austerity on to middle income earners we are killing the goose that lays the golden egg, we need to throw the goose some grain!

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