23 September, 2010 9:58
Matthew's article on the deficit in The Times today
STICK TO PLAN A AND THE GROWTH WILL FOLLOW
From Canada to Sweden, history shows governments are rewarded for deficit cutting
Matthew Hancock, The Times, 23 September 2010
It happens to me over and over again. As a new MP I do lots of radio interviews, and as I am an economist by background the same question comes up: how much will the cuts hit the economy? It goes like this. Everyone knows that we need to cut government spending, and everyone knows that if you have a debt problem, the longer you leave it the worse it gets. Most people agree that cuts will make the economy stronger in the end, and most people accept that it is deeply unfair to leave our children burdened with our debts. But my interviewers always assume that there will be lower growth in the short term.
Of course I can understand why. Cuts in public spending are tangible. On Friday I visited West Suffolk College. It was promised a £78 million upgrade, before the funding was pulled by the last Government. Cuts like that hurt.
Yet the benefits of getting to grips with our record deficit are more broadly spread. Dealing with a debt problem boosts confidence that the economy will be stable. Interest rates can be kept lower for longer as the Bank of England supports demand. International investors ask less of a premium on the money they lend.
This is happening. Market interest rates have fallen. This week the rating agency Moody's said that the UK's AAA credit rating is safe because of the Government's action. Interest rates for government borrowing for two or three years have halved since the election. Lower interest rates both save money and stimulate the economy. I grew up in a family that ran a small business, so I know just how much businesses benefit from lower interest rates. Homeowners benefit from lower mortgage rates, which matters even more since household debts are the highest in our history.
So how much will the cuts hurt the economy? I discovered that research into dozens of past fiscal tightenings shows that, more often than not, growth doesn't fall but accelerates.
A study in 2003 by the European Commission found that of 74 consolidations examined, in 43 cases growth accelerated. In the mid-1980s, Spain, Portugal, Denmark and Ireland all had to rein in large deficits and their economies grew as a result. Finland, Sweden and Italy found the same in the mid-1990s. After the large cuts made by Canada in the 1990s, its economy then grew. More recently, after tackling its deficit, Sweden is growing at more than 4 per cent.
The Government can do other things too to boost growth, such as help to get credit flowing and make it easier to take on employees. But getting to grips with the nation's finances can increase growth even in the short term.
Evidence from the past also indicates how we can get this positive result. First, cuts are most likely to lead to growth where a credible plan is set out and kept to. Where countries give up on a programme of cuts halfway through, confidence is undermined and growth is harmed.
Imagine if Bob Crow or Ed Balls were to become Chancellor tomorrow and halt the cuts. Would investors who lend so much to the Government have confidence in being paid back? Which global businesses would suddenly choose to invest in Britain? Some people who oppose the cuts keep asking: what is Plan B? But would you go into a marriage talking about Plan B? Who gets down on one knee and says: "Darling, let's talk about what happens if this doesn't work out"? Like a marriage, the surest way to end up on Plan B is to start talking about it.
The second lesson from the research is that consolidation helps growth when it's mostly done through spending cuts, not tax rises. The OECD say the best balance for growth is 80 per cent cuts and 20 per cent tax rises. If government is living beyond its means, growth can only come from private businesses; tax rises that discourage enterprise would harm any prospect of boosting that private sector growth. What type of spending is cut matters too. Maintaining capital spending and minimising public sector job losses by restraining pay and tackling welfare spending helps growth.
Finally, the evidence shows that the bigger the deficit, the more likely the cuts will help growth. Given the mess Britain is in today, at least we have this on our side. We have been borrowing one pound for every four the government spends, and the interest bill alone already costs us more than the police and transport budgets.
But if the hole is so much bigger won't the cuts hit more? I looked at the numbers. GDP grew by 1.2 per cent in the last quarter. By contrast the extra £6 billion cuts this year announced by the coalition amount to 0.1 per cent of GDP per quarter. Over the next five years, the scale of the extra cuts is the same. Compare that with the huge boost from showing the world we have got to grips with our finances. After all, the size of the State and the size of the economy are not the same thing.
Countries have been in the predicament we are in before. The evidence is clear: we can keep growth going and sort out our finances — so long as we stick to the plan.