Tim Knox: Why Cameron can’t change course on deficit

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SO far, David Cameron has shown a remarkable sensitivity. After less than a year in office, he has shown that he has the flexibility to listen to argument and to change his mind (the less charitable may say that he executes a good u-turn).

On issues such as the privatisation of forests, personal photographers, the sale of school sports fields, penalties on knife crime and a referendum on the Lisbon Treaty, the Government has reversed its policy in response to public pressure.

The pros and cons of each of these can be debated. But there is one area of policy where, whatever the public pressure (and we can expect it to be huge), the coalition cannot afford to change direction: the cuts.

If you have any doubt about that, read Five Fiscal Fallacies. In this report, published today by the Centre for Policy Studies, noted City economist Dr Tim Morgan shows how the debate over the cuts is obscured by five great fallacies.

The first of these is the idea that the UK’s past profligacy is indefinitely affordable and sustainable. This is wrong – and the numbers are stark. If we continue to borrow at the rate we are (and in November the government borrowed £700m a day – the highest borrowing month ever), then our national debt would reach 300 per cent of GDP by 2025. If anyone was still foolish enough to lend us that much money.

The second fallacy is that the economy would perform more strongly if the state continued to spend beyond its means. This does at first indeed sound plausible. How can we take all this money out of the economy and expect the economy not to suffer? Yet almost £600bn – equivalent to £24,000 for every household in the country – has been pumped into the British economy in the form of government debt and quantitative easing. And we still have a growth rate of only one or two per cent.

We cannot go on like this. And if we did, interest rates would start moving up very quickly, severely impairing economic performance and condemning millions of mortgage-paying homeowners to penury.

The third fallacy is that the planned spending cuts are “massive”. The reality is that they merely unwind a small part of the earlier profligacy. In 2015-16, the state will be spending more in real terms than it did in 2008-09.

Yes there will be painful cuts in some departments, not least because of the cost of all the extra interest which the government must pay for the borrowing it is incurring. But this is neither swingeing nor massive. It is merely unwinding some of the huge profligacy of the New Labour years (spending increased by £231bn – a fraction under £10,000 per household – between 1999-00 and 2009-10).

The fourth fallacy is that there is a direct relationship between government expenditure and the quality of public services. This is also not true. Productivity in the public services dropped sharply over the last decade – and in the NHS this could have dropped by as much as 34 per cent. The quality of any public service need not automatically suffer because of reduced levels of spending.

The final fallacy is that £1 spent by the State and £1 left in the hands of individuals and businesses is the same. This is not true. Moving resources from a high to a low-productivity sector (or from the private sector to the public sector) necessarily impairs growth. But that is precisely what New Labour did when it increased public spending from 36 per cent of GDP in 1999-2000 to 48 per cent in 2009-10.

Most of the “growth” of that period was really a bubble, with escalating debt and soaring property prices creating booms in construction, financial intermediation, and real estate while manufacturing output declined, with rising personal debt driving consumption in a manner that was equally unsustainable.

To create growth, government needs to improve not only productivity but competitiveness. The most recent Global Competitiveness Report, produced by the World Economic Forum, highlights some striking weaknesses. In the survey, the UK ranked 12th within 139 countries assessed.

The good news is that the UK has a number of competitive strengths, particularly in technological preparedness, labour mobility and market size. But some of the weaknesses are extremely striking. The UK ranks 72nd (behind countries such as Ethiopia and Tajikistan) on the wastefulness of government spending, and 89th (behind Nigeria and Zimbabwe) on the “burden of government regulation”. The survey ranks Britain an appalling 56th on the macroeconomic environment, reflecting 107th place on savings ratios, 108th on government debt and 117th on the deficit.

The impression which emerges is of a country with good technological and innovative characteristics which is hamstrung by a morass of tax, bureaucracy, waste, over-regulation and interference. That is the fruit of New Labour. Yes, there will be pain ahead for those directly affected by the cuts. Yes, there will be huge pressure on the Prime Minister to do something about that pain. Yes, he should listen. But be sure: he must not change course.

Tim Knox is acting director of the Centre for Policy Studies which today publishes a pamphlet entitled Five Fiscal Fallacies. Further details can be found at www.cps.org.uk