The Government should be compelled by law to halve the budget deficit within 4 years
The UK is currently running a budget deficit of 12%, which is higher than Greece a country that is in particularly hot water due to its fiscal imprudence. Everyone agrees that this has to be reduced, but how quickly should this be done and how far does it need to be cut? No one really knows. Governments do not like making big cuts in services as they are unpopular so introducing a law forcing a cut in the deficit within a certain time could be useful to whichever party wins the election.
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Deficits mean more debt which will be a burden when interest rates rise
The main problem is that if the Treasury does not look like it is credibly going to reduce spending quickly then investors are going to stop buying government bonds or at least will see them as less reliable. Credit rating agencies have warned that Britain could lose its triple-A credit rating. This would mean that the interest demanded for government debt would rise considerably. At the same time there is worry that the rates will rise as the Bank of England stops its policy of quantitative easing which has been keeping the interest rates on government debt down by purchasing it. QE has meant that the government managed to issue £200billion at very low rates of 4% interest.[[Giles Wilkes, The hidden cost of quantitative easing, The Guardian, 2/3/10 http://www.guardian.co.uk/commentisfree/2010/mar/02/quantitative-easing-increase-inequality%5D%5D Government debt could also be hit is the Bank of England has to raise the base interest rate due to the rising inflation above the Bank’s target. If interest rates on large amounts of government debt rise then the government could end up paying a lot more to keep that debt ticking over. This means that it is essential to get the amount of government debt down as quickly as possible.
A group of economists who argued that the government needs to reduce the spending wrote that “in order to be credible, the government's goal should be to eliminate the structural current budget deficit over the course of a Parliament, and there is a compelling case, all else equal, for the first measures beginning to take effect in the 2010/11 fiscal year."[[Economists urge swift action to reduce budget deficit, BBC News, 14/2/10 http://news.bbc.co.uk/1/hi/8514767.stm%5D%5D
Forecasts of growth are always unreliable.
The treasury has a record of being too optimistic about growth in the economy and the corresponding increases in tax revenues it will get as a result. The European Commission has recently criticized the major members of the EU including Britain for being too optimistic about growth prospects.[[EU says major powers are too ‘optimistic’ about deficit reduction, Deutche Welle, 18/3/10, http://www.dw-world.de/dw/article/0,,5365147,00.html]] This is even more the case because we are in a turbulent period which makes it much more difficult to make long range forecasts with any accuracy. Due to this it makes sense to be prudent and cut the deficit quickly rather than be locked into an ever expanding (or even only slowly reducing) deficit that creates a very large and burdensome national debt.
On the other hand if the forecasts turn out to be towards the lower end then the government will get more money from taxes and have to spend less on social security so can either quicker reduce the deficit or reinstate some public spending that it has cut back.
The unreliability of forecasts should not be seen as a reason to cut back on spending because this may well simply be proving low ball forecasts right by lowering the growth so creating a self fulfilling policy. Instead it is best for the government to wait and see what really happens and then react quickly to the situation the deficit and spending are in.
Business wants the deficit cut
A survey by British Chambers of Commerce showed that 41% of companies believe that an incoming Government should make reducing the budget deficit its number one priority. The Director General of the British Chambers of Commerce David Frost says “The message from business is clear. After an election, we have to get a serious grip on the country’s public finances and escalating debt. Cutting the deficit means making tough decisions on spending, like freezing the public sector wage bill and reforming public sector pensions.”[[BCC: The message from business is clear: Reduce the deficit and scrap the NICs hike, Politics.co.uk, 15/2/10 http://www.politics.co.uk/opinion-formers/press-releases/economy/taxation/national-insurance/bcc-the-message-from-business-is-clear-reduce-the-deficit-and-scrap-the-nics-hike-$1360219$1285171.htm%5D%5D
The view from business is however not reliable as it is not unbiased. They are not too bothered about cuts in public spending as it does not affect them as a business. Cuts to the NHS or education are not directly relevant to them in the way that tax rises on areas like national insurance are.
In the long term with an aging population the UK economy will not grow so fast
As will all other western nations the UK is aging. At the moment there are now four people of working age supporting each pensioner, by 2035 it will be just two and a half, and by 2050 only two. This presents a major long term problem as it is the National Insurance from current workers that pays for today’s pensioners. Unfortunately we do not simply add into a pot that we then take out again later when we retire. Also there are many other costs of an aging society. The biggest will likely be the expanding cost of healthcare.
The aging population means that the long term prospects for bringing down a long term deficit and national debt are grim. Obviously it is possible to bring a ballooning debt back down even if it gets up to 70% of GDP but this will only get harder and harder as time goes on because the economy will not grow as quickly as it ages and there will be more spending on health and social care.[[George Magnus, Dependency time bomb, 4/2/09, http://www.guardian.co.uk/commentisfree/2009/feb/04/ageing-population-care%5D%5D
This means that we need to focus on using the resources we have better, so we need more spending on further education and universities rather than less so that those workers we have add more value to the economy.
Need to focus on the long term
We should not be looking at the current deficit but rather on the longer term outlook of the national debt.
This means that once growth returns we can be reducing the deficit and national debt. However in the mean time we should be putting in place the investment to ensure faster growth.
The markets will not let us just focus on the long term. Like it or not in the UK investors are looking for relatively short term profits. They are likely to punish policies that are focused on the very long term. So investment in education may be good and eventually pay back but it is likely to be seen as non essential by both government and the markets, hence we are cutting back spending on our Universities which should be our investment for the future.
Should be dependent on the strength of the recovery
At the moment it is the public sector that is driving the recovery. Consumer spending and private investment has not yet picked up to the point where they can drive growth for the whole of the UK. This means that at the moment the recovery, such as it is, is being powered by the public sector. As private spending fell public spending rose, thus creating the deficit. However it would be counterproductive to cut this back until private spending has picked up or else we will immediately be tipped back into recession.
Would mean job losses
Any cuts in public spending are going to mean job losses somewhere. All parties want such cuts to fall on ‘faceless bureaucrats’ rather than ’front line services’ however for the economy this makes very little difference. Whoever has their pay cut or loses their jobs they are going to be spending less in the shops so having an impact on the economy as a whole.
The gravy train for the public sector should not continue indefinitely. It is good that the public sector has been used to tide us over the recession however it is now time to cut back the public sector. There is no reason why the public sector should keep getting pay rises and increases in the number of employees. Far from being bad cut backs in the public sector will make it more efficient.
What do you think?