Is Austerity The Right Strategy?

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David Cameron has told the Daily Telegraph that he "can’t see any time soon when... the pressure [for austerity] will be off". The cuts, suggested the prime minister, could continue until 2020. But is austerity the right strategy for the UK economy?

Below, Ruth Porter from the free-market thinktank, the Institute of Economic Affairs (IEA) debates Keynesian economist Ann Pettifor, director of Prime: Policy Research in Macroeconomics.

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Ruth Porter Communications Director, Institute of Economic Affairs

Austerity until 2020, so says David Cameron today. It is not at all clear though what he means by this.

The government needs to work harder on eliminating the deficit. Their timeframe for getting rid of it has already slipped from a target of 2015, until 2017. Surely Cameron is not now suggesting they won't manage it until 2020?

Public spending is around 47% of GDP and the deficit this year alone is forecast to be around £92bn. With a national debt already over £1 trillion, by the end of this Parliament it will be around £1.5 trillion. The government has increased taxes to try and begin to close the deficit and has also made minor spending reductions - but the size of these has been woefully inadequate.

Running a deficit is the root of many of our problems. It adds to the national debt, driving up interest payments and stifling growth. It is a vicious circle where poor growth exacerbates the deficit, and having a deficit makes prospects for growth tougher.

The key to closing the deficit lies in reducing the size of the state through proper reform of its functions. In turn this will give the government space to make tax cuts which will stimulate growth. We have ended up with such an unyielding deficit because government spending has grown to such a huge proportion of our economy it has squeezed out private enterprise and reduced incentives within the private sector.

Cameron must be more ambitious if he is to cut the state down to size. We need to remember when Tony Blair took office, spending was around 38% of GDP. Under New Labour the scope of the state dramatically increased, for example with more and more people brought into dependency on welfare.

We can't wait until 2020 to close the deficit; we need to act on that now. But perhaps it would be a useful target to aim at trying to reduce the size of the state to 30% of GDP by then. The next spending review could be an opportunity to set out a plan for what this might look like. It would require a thorough, honest and imaginative assessment of government. And the political courage to see it implemented in the face of opposition from many special interest groups that currently benefit from favours doled out by government.

We talk of austerity as if it were severe, a punishment imposed on us for past recklessness. It is though about opportunity and freedom. Allowing people to keep more of their own money, have more of a say over their own lives, being more innovative in how we access decent healthcare, education and other services will drive up standards. A smaller state will mean more jobs, more houses and a better quality of life.

Forget 2020, Cameron needs to act now.

Ruth Porter, Communications Director, Institute of Economic Affairs

Ann Pettifor Director of PRIME Policy Research in Macroeconomics

The British government's economic strategy is in tatters.

On the one hand the Chancellor, the Rt. Hon. George Osborne has just offered assurances to the private sector that the British taxpayer will guarantee £50bn of new infrastructure investment and exports.

On the other, the coalition's deficit reduction programme has largely been implemented by - wait for it - massive cuts in infrastructure investment. This at a time when Britain - in contrast e.g. to China - invests far too little in the public infrastructure that supports and enhances private economic activity.

By slashing public infrastructure investment the Coalition government is cutting the legs off Britain's race to recovery, and undermining its ability to compete in the global economy.

The contradictory approach to investment exposes deep flaws in the economic ideology driving austerity in Britain, Europe and the US - an ideology plunging western economies deeper into recession. No wonder the governor of the Fed, Ben Bernanke was so downbeat last week. And no wonder the British PM promises years of doom and gloom to his electorate.

It gets worse: the Chancellor's new proposed £50bn taxpayer guarantees may well prove more expensive than direct public investment, because the government will be guaranteeing private sector borrowing, currently much higher than public sector borrowing.

In this sense, the Chancellor is copying the costly PFI strategy of the Labour government - a strategy which Coalition ministers were keen to disparage only a few weeks ago.

The Coalition's taxpayer guarantees for private investment follows immediately on from yet another £80bn taxpayer subsidy to Britain's private banks. However the former - taxpayer guarantees for private investment - are heavily conditional on projects taking off soon - and delivering results for the Coalition before the next election in 2015.

While these public subsidies may offer some solace to the depressed private sector, the greater risk is that the Prime Minister's 'gloom and doom' predictions will further depress private sector confidence, discourage private investment plans and cancelling out the promise of taxpayer guarantees.

Austerity - slashing public investment at a time when private investment is inhibited by a vast overhang of private debt and by a heavily indebted and broken banking system - is indeed a disastrous economic strategy, both for Britain, the Eurozone and the US.

No wonder therefore that the UK economy has shrunk by a massive 4.4% over the last four years, while the Eurozone economy shrank by 2% and the US has only grown by 1.2%.

By contrast China, which has used both monetary and fiscal policy to support private sector activity, has had more than 9% annual average growth throughout the four years since the crisis began in 2007. China, which responded rapidly to the collapse of the western financial system, mounted a massive fiscal stimulus in response to the crash. The stimulus amounted to 13% of GDP in 2008. This contrasts with the UK's weak stimulus of 1.5% of GDP and the US's 2009 fiscal stimulus of 5.9%.

China's public investment policy has been good for business. Above all, it has been good for public finances. Chinese fiscal revenue in 2009 soared by 11.9%, whereas tax revenues collapsed for both the UK, the US and the Eurozone saw tax revenues collapse.

China might be slowing down - but slowing down to about 7% increase in GDP is a record that Britain's politicians can only dream of.

Instead the British Prime Minister offers only the nightmare of 20 years austerity.

Ann Pettifor is Director of PRIME Economics

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