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Sat 23 Oct 2010 12:00 AM

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Seeking a 'least painful' austerity formula for Britain

It’s one thing tightening the purse strings, but another to keep the wheels of commerce greased

Seeking a 'least painful' austerity formula for Britain
Seeking a 'least painful' austerity formula for Britain
UK Prime Minister David Cameron’s five-month-old coalition government faces a daunting task of formulating the country’s austerity drive.

Everyone in Britain knows cuts must be made. But how, and where? It’s one thing tightening the purse strings, but another to keep the wheels of commerce greased.

Taking the axe to pension benefits rather than jobs, and cutting bureaucracy rather than infrastructure investment, are what Britain's austerity drive should focus on to render the smallest hit to economic growth.

If finance minister George Osborne is to achieve the 83 billion pounds ($133bn) of spending cuts he promised in his June budget some degree of economic pain is inevitable.

But economists say how hard Britain’s growth potential is hit will ultimately depend not just on the figures but also the profile of the cuts: how they are spread and how much of the burden is borne by the welfare state.

Judging by the drip-feed of announcements ahead of next week’s Comprehensive Spending Review, Britain’s five-month-old coalition government has taken heed.

In the past two weeks it has announced cuts to pension tax relief, a cull of publicly-funded regulatory bodies and the end of universal child benefit payments.

Those measures indicate a direction of travel they represent only a small part of the overall austerity programme.

Although the statement will not detail every project that has been pared or abandoned, it will shape views on how likely the government is to achieve its debt-cutting goals and whether recovery will be blown off course in the process.

For each pound spent, different areas of government expenditure have a different impact on GDP growth — something economists know as the domestic multiplier effect.

These calculations are theoretical but they throw up some interesting thoughts on what an “ideal” austerity package should look like, at least from the point of view of GDP growth.

Construction projects, which tend to be labour intensive and require few imports, score highly on the multiplier scorecard. The same goes for infrastructure investment, which has the added benefit of improving productivity.

Britain’s independent Office for Budget Responsibility estimates every pound of capital spending by the government boosts gross domestic product by exactly that amount, while every pound spent on welfare generates just 60 pence.

When it comes to the public sector payroll, savings from pensions and wage restraint are far less damaging to an economy’s growth potential than job cuts which often result in costly redundancy payments and a higher welfare bill.

“If I had to give two recommendations it would be not to cut capital spending so much and to try to find ways of minimising public sector jobs losses,” said John Hawskworth, head of macroeconomics at consultancy PWC.

“The private sector was flexible with regard to pay and working hours during the recession and this meant unemployment did not rise as much as feared. We need to see the same happen now in the public sector.”

Political history is littered with failed government initiatives to slash the welfare state, particularly in trying economic circumstances. And this time, from a growth perspective, Osborne should be wary about wanting to.

Welfare cuts by nature have a greater impact on poorer families who, according to textbook economic theory at least, have a higher propensity to consume.

The bulk of welfare spending is also highly dependent on the economic cycle, which makes it much less predictable.

“Benefits are more difficult to contain if the economy slows,” said Sam Hill, fixed income strategist at Royal Bank of Canada. “The pressure to find more savings from benefits rather than departmental cuts makes the fiscal contraction more sensitive to economic growth.”

The government's hope is that tight fiscal policy will allow the Bank of England to keep interest rates lower for longer — something that will help private enterprise expand to fill the gap left by a shrinking state sector.

This was also the rationale behind the government’s insistence that spending cuts, rather than tax rises, bear the brunt of the fiscal retrenchment. Its aim for an 80:20 split is ambitious, both relative to austerity packages in other parts of Europe and relative to history. During Britain’s last fiscal squeeze in the early 1990s the then Conservative government aimed for a ratio of 50:50.

millicent 9 years ago

They should also cut all the additional expenditures and privileges the MP and whoever is working in the public sector. All the money they take in brown envelops!!! not only they take our money which should be used to something else than them having
summer and winter houses, drivers and servants, etc. but on top of all this they do not pay taxes on the brown envelops nor on the priviledges they have!!!! so we are missing twice on these so called super people! But of course this will not be touched unless things will go so bad that at the end they will be push into it as they won't be able to do differently. In any case they have to stop stealing the money and thing the private sector will pay for it all.
The good thing in all this is that now truth is coming up!