George Osborne’s dangerous numbers

“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.” This is the immutable financial insight told to David Copperfield in Charles Dicken’s eponymous classic. The quote neatly underlines the common sense wisdom to spend less than you earn. And as Adam Smith said, “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.”

We can apply this logic to the spending cuts announced by George Osborne yesterday. The Coalition has, as promised, set out £6 billion worth of cuts, including £1.1 billion from discretionary spending and some £600 million from quangos. But these numbers are deeply disappointing.

It is an obvious point, but worth restating, that our deficit is £159.2 billion per year. Every single year, we borrow and spend more than we earn, and last year that figure was more than the GDP of New Zealand. This is unsustainable. Osborne would need to make cuts of not £6 billion but £160 billion to balance the books. Moreover, debt is nasty and it compounds: the government is already wasting a significant proportion of its income servicing debt interest.

There’s another problem too – the kind of borrowing that the government undertakes. Borrowing to buy a house generally makes sense; over the long term, property prices are expected to rise. Borrowing to buy a car, on the other hand, can be a bad idea because cars depreciate in value, losing money. The lesson is that it is sensible to leverage to purchase things that will increase in value (or produce income). However, the government’s spending is worse even than the proverbial car. It borrows to provide services which have zero resale value: the money is literally going down a black hole. Gordon Brown perhaps knew this when he invented the Golden Rule: only borrow to invest. However, it is patently obvious that the Labour government quickly abandoned this principle.

Unfortunately, George Osborne’s announced spending cuts do not even come close addressing the resulting debt problem. The new government, despite the spending cuts, will continue to borrow heavily, risking dragging the UK into a debt spiral. For a government formed of two parties that were so critical of Labour’s economic record, their solution surely cannot be to borrow a feeble 4% less than Labour did in its highest spending year.

8 thoughts on “George Osborne’s dangerous numbers”

  1. Posted 25/05/2010 at 11:39 | Permalink

    If and when the economy comes out of recession perhaps as much as half of the current annual deficit of about £150 billion should disappear, as tax revenues rise and social security payments decline (that is to say, as the ‘automatic stabilisers’ unwind).

    That leaves £75 billion a year of ’structural deficit’ to be eliminated.

    If Mr. Osborne sticks to the 80/20 split he suggested before the election, £60 billion needs to come from government spending cuts and £15 billion from tax rises.

    Given that the recently-announced £6 billion cuts come part-way through the year, maybe they are equivalent to an annual rate of £7 1/2 billion — or one eighth of the total rate of cuts required.

  2. Posted 25/05/2010 at 11:46 | Permalink

    The new coalition should borrow an idea from Keynes, and identify ‘non-agenda’ of government. What is government spending taxpayers’ money on which it doesn’t need to do at all, and which could either not be done at all or else left to the private sector?

    Given all the fuss about a mere £6 billion of cuts, it would seem impossible to multiply that by a factor of about eight just by more of the same. Surely some whole programmes need to be eliminated… And, in the longer run, perhaps government activity can be reduced by still larger amounts.

    £60 billion a year is only 4 per cent of national income; yet government spending has risen by 10 per cent or more since 1997.

  3. Posted 25/05/2010 at 11:53 | Permalink

    He cannot cut taxes too sharply due to the loss of demand. If he could compensate for the lost demand by other means (perhaps velocity of money) there would be room for further cuts but he has made no effort to do so. He also intends to do an emergency budget in June so there will be greater cuts then. This is just the start.

  4. Posted 25/05/2010 at 13:17 | Permalink

    David makes an important point – that what needs to be aimed at is the structural deficit rather than the deficit in recession. However, as he says, that is still a very difficult task and can only be done by taking a radical view towards some major categories of expenditure. Candle-paring and not replacing people who leave is just not a plausible strategy.

  5. Posted 25/05/2010 at 13:31 | Permalink

    A prudent government would go beyond the so-called ’structural deficit’ and look to balance the books as quickly as possible. One cannot assume that growth will be robust in the medium term. Indeed, there are strong reasons to be bearish on growth, including the impact of measures to meet ambitious climate-change targets and the longer-term implications of recent monetary policy. High levels of government borrowing also leave the UK very exposed to external shocks.

  6. Posted 25/05/2010 at 16:01 | Permalink

    I also say we should go beyond the structural, for by the time the economy begins to recover, the debt will be significantly higher and it should be cut back and one would hope eliminated.

    To clear it away we surely would have to have growth in tax revenues occurring faster than the rate of interest on those loans, otherwise we are just not keeping up. Seeing as revenue will remain below debt, that would also suggest growth must exceed it by 50% or more to make any dent.

    Cuts in expenditure to eliminate the deficit, then to make inroads into the debt seems to me to be the only logical and sustainable option.

  7. Posted 25/05/2010 at 16:56 | Permalink

    As Obama’s sidekick asked, why waste a good crisis? The need for drastic cuts ought to be the opportunity for reducing the welfare state to the safety net it was originally intended to be, and for asking what the NHS is really for – if we have to have nationalised healthcare, does it really have to cover things like fertility treatment? Subsidised food, carparking etc? 60% of prescriptions free?
    As far as the timing of the cuts is concerned, my instinct is that the deeper they are, the faster the economy will recover. The longer they are protracted, the more private-sector investment decisions will be delayed until the uncertainty is resolved.

  8. Posted 25/05/2010 at 23:02 | Permalink

    […] Arquivado em: Economia,Internacional,Política,Teoria — André Azevedo Alves @ 00:02 George Osborne’s dangerous numbers. Por Adam Lyons. Osborne would need to make cuts of not £6 billion but £160 billion to balance the […]

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