Comment: Getting it right, at last!

Andrew Lilico is chief economist at Policy Exchange
Andrew Lilico is chief economist at Policy Exchange

George Osborne's emergency Budget finally starts to turn things around.

By Andrew Lilico

In real terms, there is about £100 billion in reduction in the deficit over this parliament - exactly what's needed. He's taken about £10 billion off the benefits bill and reducing spending on our bloated public sector by more than £60 billion. Spending is now scheduled to come down from the absurd level of about half of the economy that Gordon Brown had inflicted upon us back to the 40% level that had worked well through the 1990s until 2007.

Unfortunately, taxes have had to go up as well, to cut the huge and foolish deficit that Brown had refused to reduce. No-one is going to like that, but it's had to be done. They haven't raised quite the taxes I'd have preferred - raising the basic rate of income tax might have been better than raising VAT - but whichever way you spun it, taxes needed to rise.


But the big story here is spending. Under Gordon Brown there were two great surges in public spending. From 1999 to 2005 he raised spending from about 36% of GDP to 41%. Sounds like a big rise, doesn't it? But then from 2007 onwards he really got going, raising spending to around 48% of GDP by last year. Spending went up an incredible £120 billion in just three years.

Some people would like you to imagine that this money was spent on the banks, but it wasn't. The £120 billion is the rise excluding the support for the banking system. Other people would like you to think that it went on some kind of 'Keynesian investment programme', spent on bridges and hospitals and other public works. But in fact just six per cent of that £120 billion was spent in that way. Well, was most of it spent on the costs of the recession, then? No! Less than a third of the rise was anything to do with the recession at all.

The vast majority of this huge rise went on government consumption - things like extra staff and higher public sector pay. This was fiscal nihilism posing as wisdom, irresponsible squandering of resources posing as a policy. From 2007 to 2010, the public sector partied like it was 1999.

But all parties must come to an end some time. This one ended when the money ran out, with UK public spending rising so far so fast that it threatened to derail economic growth for the next decade, and the deficit rising so high that people started to worry that financial markets would lose patience and not lend us any more money.

We've seen in Greece and elsewhere how quickly financial markets can turn against a government if it doesn't act. For months or even years, everything seems okay, but then suddenly markets lose confidence and matters turn dark. There was a real risk that that could happen in Britain in a couple of years' time. With Osborne's plan, that risk should be gone.

Our economy needs growth, and it needs it quickly, so we can keep down unemployment, pay our debts (both the state and household debts), and enable the banking system to recover and get off government subsidised life-support. The quickest way for the government to deliver growth is to cut spending. At lower levels of spending (say, the 40% of GDP the emergency Budget will bring in) the economy will grow more rapidly in the medium term, meaning that wages will rise as well. Since people's wages will rise faster in the medium term, people will feel more confident to spend even today.

With spending cuts doing nearly 80% of the work in cutting the deficit, the fear of tax rises will be lower. If taxes are not going to rise as high in the future, then people will be richer and so feel more able to spend even today. And with a lower deficit, interest rates won't spike up, ruining the recovery.

Of course, the real challenge now begins: how to deliver the £60 billion plus of cuts to the public sector promised. Osborne says he will tell us more about that in the autumn. With the NHS ringfenced, that means cuts in other departments of 25%. The NHS would rise from 28% of public service spending today to 37% in the future, a rise of one-third over a parliament. Even Labour only increased the role of the NHS by one-tenth in the last parliament. Our health is, of course, very important, but is the NHS really that much more important than everything else? Don't education and defence and the police and so on count at least a bit? If we have to cut defence spending by 25% that will take it back in real terms to its 1950 level. Is that really the way to go?

All these questions still lie ahead of us. And they are tough questions that will involve tough answers however the debate finally goes. Osborne announced a two-year freeze in public sector pay. But that will only be the beginning. There will probably have to be extensive reductions in jobs in the public sector, perhaps as many as 600,000 (one-tenth of the total). The total pay bill may need to be frozen, not simply the entry pay and grade boundaries as Osborne announced. There will need to be other cuts - in IT, in other equipment, in consultants.

The total cut is around 11% of spending. The largest spending cuts achieved in any one year since the Second World War were in 1977, when the IMF insisted we cut spending by 4% before they'd agree to bail us out. There was a general strike (the Winter of Discontent), bodies were left unburied, rubbish lay in the street, the German chancellor declared Britain "no longer a developed country", there were riots. And that was just one year. We need three years in a row of cuts almost that big.

It had to be done. But no-one's going to like it. If George Osborne didn't want to be one of the least popular men in Britain, he should have got another job.

Andrew Lilico is chief economist at the thinktank Policy Exchange

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