Budget 2015: cuts to make Daily Mail readers wince, but not just yet

Hard hat area. Osborne will struggle to sell his version of growth. Number 10, CC BY-NC-ND

George Osborne is preparing to deliver the first Tory budget since 1996. He will proclaim the success of the government’s “long-term economic plan” and will use this as a platform to launch a radical reduction of welfare expenditure. But repeatedly extolling the success of your long-term economic plan does not mean that you have one. And an economy that in the first quarter was growing at a sluggish annual rate of 2.2% per head – after a deep and protracted recession – is not an indicator of sustained economic revival.

There are two main components of the government’s economic plan. First, to decrease the budget deficit and eventually move it to surplus – with the fiscal burden being borne by cuts in government spending. Second, to reduce the size of the state in the British economy. This is not an “economic plan”, it is a political agenda based on a doctrine of faith.

The focus on fiscal austerity has meant that monetary policy (interest rates and quantitative easing) has been the main stimulant to the economy. Thus, private sector debt is considered good and desirable whereas public sector debt is bad and harmful.

This makes little economic sense; what is important is the appropriate balance between borrowing to consume and borrowing to invest. In a period of cheap money, it is no surprise that consumers are buying new cars in record numbers (85% of which are manufactured abroad); the problem is that the state is not investing in the infrastructure that the economy needs.

The growth record

The supporters of austerity have argued that the return of economic growth is justification for the policy. This argument is full of holes. The anti-austerity group never argued that the economy would remain in a permanent recession – their concern was that recovery would be delayed and the downturn would cause long-term damage. The normal path for an economy that suffers a shock is that it bounces back with a period of rapid economic growth. The bounce-back has been feeble in the UK and growth has yet to get back to trend.

Furthermore, the most important indicator of prosperity is GDP per capita, and as shown by the red line in the chart below, this is still below the level achieved in 2008. This reflects the UK’s productivity problem. As the liberal economist Paul Krugman observed:

Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.

Although it will probably receive a lot of lip service in the budget, there has been no coherent plan to raise productivity in the UK.

ONS, Quarterly National Accounts, Quarter 1 (Jan to Mar) 2015

The retreat of the makers

The UK remains an unbalanced economy: regional disparities have widened since the early 1980s and this process was not halted by the financial crisis. The government has proclaimed that it is putting the power into the “Northern powerhouse”. But regional policy in the UK is piecemeal and parsimonious; and you do not build a powerhouse by postponing infrastructure spending in the North.

Support for industry is another area where soundbites trump substance. The chancellor has called for “a Britain carried aloft by the march of the makers”. But as the chart below shows, although there has been a recovery of the service sector, the manufacturing sector remains smaller than it was before the financial crisis.

The coalition government revived the notion of “industrial policy” to support the manufacturing sector; but this was a Vince Cable initiative which is not being pursued by the current government – which is instead implementing major cuts at the Department for Business, Innovation & Skills, the department responsible for business support and innovation.

ONS, Quarterly National Accounts, Quarter 1 (Jan to Mar) 2015

Of course, it is often argued that manufacturing does not matter any more as we are a service-based economy. Services will continue to provide most of the jobs and most of the output of the economy. Where manufacturing plays a crucial role is as an important source of exports: to help address the deficit that the chancellor rarely talks about – our massive and persistent trade deficit with the rest of the world.

The size of the state

An important part of the long-term political plan is to reduce the size of government – to wield the axe to what the Daily Mail refers to as the “the bloated overweening state”. This is a big challenge as the size of the state (as a share of GDP) has increased in all advanced economies since World War II.

This has not been due to some statist plot, but reflects the implications of prosperity. As economies have grown and the standard of living and life expectancy have increased, there has been expanding demand for health, education and pensions. And much of this demand has been met by the state and funded by tax revenue. These are the largest components of government expenditure in the UK; and if the chancellor is serious about reducing the size of the state this is where his axe will have to eventually fall.

Hitting benefit claimants in the meantime is an easy target – and, after all, not many of them are likely to vote Conservative. But large-scale cuts to school budgets, the NHS and state pensions may even make some readers of the Daily Mail wince.