Since 2007, the global financial crisis engulfed several leading economies and placed them in a precarious position. Output in many G20 nations declined and it was the worst downturn since the Great depression. When an economy is growing we notice that more people find work, credit is easier to obtain and living standards for the majority of society tends to rise in harmony with the economy. In a downturn and recession (defined to two consecutive quarters of negative output) the opposite tends to occur, less jobs created, rise in unemployment and usually a rise in income tax to compensate for the lost output.
Since the coalition in the UK came into power in May 2009, Chancellor of the Exchequer George Osborne has led the way with polices aimed at reducing the UK’s deficit. A deficit is the sum of government debt, deficits being a flow variable and debt being a stock variable. As we have all heard, this is his primary aim, so we have seen large reductions in government expenditure, in an attempt to curb government spending because the current government deem it too high. Fair enough, Labour may have binged a little on spending and some savings needed to be made. But, the best way to reduce government debt and therefore the deficit, is to stimulate economic growth. It is economic growth that will reduce the deficit, not only will growth translate into more jobs being created, more goods & services made available and more disposable income for households, but it will also help the government achieve their aim of deficit reduction.
It is this failure of George Osborne and Business Secretary Vince Cable to recognise this that has made me ask the question, is economic growth even their aim?
The OECD has backed Osborne’s economic policies, suggesting that fiscal consolidation is an urgent requirement. Whilst I can accept that, there are policies that the government could bring in in order to increase public spending. They have not. When the government came into power one of their first economic decisions was to increase VAT from 17.5% to 20%. This increase of 2.5% makes everyday goods that have VAT attached 2.5% more expensive. If you want people spending, make things cheaper, it’s that simple. Retailers had a rather subdued Christmas, had VAT being 15% or even 12.5% then I’m sure it would have had a significant difference.
The UK is also not a member of the Eurozone. This should provide a bit of protection from the farcical situation currently engulfing several imbalanced economies. Whilst the UK is very close to the other nations, the fact that it can manipulate its currency should provide some breathing room in which it could devalue the Pound and attract new business. With the Chancellor cutting cooperation tax, the UK should be seen as an ideal location for business. However, whatever effect the domestic currency is having alongside the competitive cooperation tax rates is clearly not penetrating the economy strong enough and the recovery is taking much longer than it should be. Moreover, incomes generated by large firms do not appear to be trickling down to the rest of society. Unemployment in the private sector confirms this, as it is increasing at a sluggish rate.
All of these factors combined makes me wonder if all this austerity is actually worth it, because the opportunity cost of allowing the economy to stroll along in this mundane manner represents time lost. It just appears that the government is holding back for future consumption. It is a dangerous move in my opinion because it could lead to large structural damages that could take several years to repair.
The Chancellor will be providing a new Budget soon and I’m sure it will contain more of what we have already heard.
I’ll conclude with the fact that David Cameron does not think you tackle a debt crisis by issuing more debt (governments increase debt when they spend). However, as so long as jobs are created, taxes are paid and the economy is growing the level of debt does not matter because the positive effects of economic growth cancel the negativity associated with the debt. It is when an economy is not growing that the level of debt and deficit becomes an issue. Furthermore, there is not a single large economy that has cut its way to growth, so if it does happen in the UK all of this austerity will be worth it. The benefits do appear to be a long way away right now.