The Cameron Precedent?

by Andrew Stuttaford

There’s been a lot of talk about how, despite their distinctly mixed electoral record, Cameron’s budget-cutting British Tories could constitute some sort of example for the GOP. There’s something to this — Republicans could certainly do with a little help in that department – but as this piece by Rupert Darwall in the WSJ suggests, the Cameron precedent has to be treated with some care:

Announcing the British government’s spending cuts on Wednesday, Chancellor of the Exchequer George Osborne declared that it was the day the country had stepped back from the brink. In some ways, it was more than that. Mr. Osborne had decided that Britain would not join President Obama and America on a journey back to the 1970s, when the U.K. had a lost decade and America suffered from Carter malaise.

For Mr. Osborne, the announcement turned out to be a political triumph.  The public accepts that spending must be cut. These numbers illustrate the scale of the problem: Over the past 10 years, the U.K.’s GDP increased by £160 billion (after adjusting for inflation), but government spending grew by £217 billion, one third more than the increase in economic output. During that period, the extra spending on the three biggest items of government spending alone—social security (including pensions), health, and education—took 88% of the extra GDP Britain had generated. Something had to give and the coalition was right that the bulk of it should fall on the spending side.

After Wednesday’s package, there will be a sharp deceleration in public spending. In nominal terms, government expenditure is still planned to increase by £43 billion through 2014-15. But GDP is forecast to grow by £330 billion over the same period. With extra public outlays absorbing just 13% of additional GDP, the government expects that spending will fall to 41% of GDP by 2015 from more than 47% now .

So far so good, but . . .

The risks to the coalition’s economic policies lie not in what it has done, but in what it isn’t doing. The government plans to increase public spending by more than 6% over four years. In the context of a structural deficit of around 10% of GDP, the government won’t be able to close the gap between taxes and spending without robust economic growth.

 

Politically the coalition won’t get such a good chance again to get the overall fiscal side right.  Returning for a second time is likely come at a high political cost. But there is very little in the public spending package to boost productivity. Rather the package has been skilfully designed to bind the coalition together and, by shifting resources from the welfare budget to health and education, to wrong-foot Labour.

In terms of neglect of supply-side policies, three areas stand out. First, the coalition shows little understanding of the importance of incentives. In addition to granting full child benefits to those earning £43,874 and under while eliminating them for those earning £43,875 and over, the chancellor on Wednesday proposed still more changes to the complex system of tax credits that further undermine incentives for those toward the bottom of the income scale. The government’s rationale for freezing the level of the tax credit that people get for working, but increasing the value of the tax credit they get for having children, is rooted in meeting an arbitrary measure of “child poverty.”

Throwing money at a problem rather than solving it is never the right thing to do, least of all when there’s a towering deficit. The coalition promises a top-to-bottom reform of welfare so that work always pays, but it won’t be fully implemented until 2020. Britain simply can’t afford to wait that long.

The second area is the distortion to the energy market in the name of building a low-carbon economy. The failure of the Copenhagen conference last December to agree a global cap on greenhouse-gas emissions means that the social value of saving a ton of carbon will be zero for the foreseeable future. Yet the coalition plans to hobble the economy with a raft of regulations, levies and spending, including creating a green investment bank and spending £1 billion, plus proceeds from sales of various state assets, on energy projects of no value. 

The third area is the protection of large public sector capital projects from spending cuts.  Former Fed chairman Alan Greenspan has commented on the large fraction of world savings that are wasted financing unproductive capital investment, especially in the public sector.  There is little evidence that Britain derives higher returns from such investments than other countries. The fiasco of Britain building two aircraft carriers it doesn’t want anymore simply because the cancellation penalties allegedly exceed the production costs suggests the opposite. 

After nearly two decades in which economic expansion was taken for granted, politicians need to discriminate between policies that really fuel growth and those that just amount to fluffy soundbites. By deciding to close the deficit, the coalition made a tough call—one that pulls Britain away from repeating some of the worst mistakes of the 1970s. But it also needs to focus on supply-side policies to help the economy grow faster. 

In the 12 months leading up to the 1983 re-election of the Thatcher government, the U.K. economy grew 3.3%. In the 12 months preceding that, it had grown 2.0%. Policies focused on growth are the coalition’s only way to ensure that it doesn’t have to return to the House of Commons to announce another raft of spending cuts—or tax increases.