U.K. Budget Cuts May Lead to Depression: David G. Blanchflower

It was always David Cameron’s election to lose.

Everything now points to a hung U.K. parliament where none of the parties gains an outright majority in the election on May 6. The Conservative Party, led by Cameron, says a coalition government would be a disaster. He’ll have another opportunity to make that case in today’s third and final televised debate.

George Osborne, the Conservatives’ Treasury spokesman, said this week a hung parliament posed risks “for our economic stability” and would lead to “a paralyzed economy.”

The idea that the economy would be paralyzed if there were to be a hung parliament is codswallop. The financial markets have had time to discount such a prospect and there has been little or no response from them. The FTSE 100 Index has risen 3.6 percent this year and the pound has strengthened slightly against the U.S. dollar since the beginning of March, as the polls narrowed. Gilts show no sign of imminent collapse.

Arnaud Mares, lead U.K. analyst of the ratings firm Moody’s Investors Service, indicated this week that a hung parliament didn’t have direct implications for the U.K.’s AAA rating.

The real issue that Prime Minister Gordon Brown and Liberal Democratic Party leader Nick Clegg should address in today’s debate with Cameron is the Conservative Party’s proposals to cut public spending by an additional 6 billion pounds ($9.1 billion) in 2010 in an emergency budget within 60 days of being elected.

‘Rash’ Proposal

This proposal was opposed by Brown’s Labour Party, as well as the Liberal Democrats, and generated a furious letter to the Times from 77 economists arguing that it was “rash” and “destabilizing.” Their main point was that only when the recovery is well under way, would it be safe to have extra cuts in government expenditure.

Just as Bank of England Governor Mervyn King said in testimony before the Treasury Select Committee on Nov. 24 last year, the budget deficit should be reduced “at a rate that is consistent with the restoration of growth in the economy.”

The U.K.’s fiscal shortfall was 11.5 percent of gross domestic product in 2009, according to the European Union’s statistics office, Eurostat. British GDP rose 0.2 percent in the first quarter from the previous three months, the Office for National Statistics said this month.

Colin Ellis, an economist at Daiwa Capital Markets in London, agrees it is too soon to cut.

‘Back Into Recession’

“Growth is the No. 1 priority right now,” he says. “The private sector hasn’t been crowded out by the public sector in this recession -- instead, the public sector has supported the economy. Wielding the ax too enthusiastically now runs the real risk of tipping the economy back into recession.”

Interestingly there isn’t that much to choose between any of the three parties in terms of their fiscal projections -- all intend to hack public spending over the next parliament. Chancellor Alistair Darling even admitted that Labour’s planned cuts in public spending would be “deeper and tougher” than Prime Minister Margaret Thatcher’s in the 1980s.

None of the three parties has come clean on precisely where any cuts would fall, although the National Health Service apparently is to be ring-fenced from austerity measures.

According to a report this week by the Institute for Fiscal Studies, the Conservatives would need to cut spending in real terms by almost 64 billion pounds a year from April 2011 to March 2015. The Labour Party would cut by about 51 billion pounds and the Liberal Democrats by 47 billion pounds.

Policy Gaps

The institute said the Conservatives have announced measures that would bring about 18 percent of the total cuts they need, leaving a shortfall of 52.4 billion pounds. Labour’s would bring about 13.1 percent of what it would need, leaving a gap of 44.1 billion pounds. The Liberal Democrats have gone public with policies that would bring about 25.9 percent of what they would need, leaving 34.5 billion unaccounted for.

The big issue, though, is growth projections. What if the GDP forecasts, upon which the budget cuts are based, aren’t achieved? The Treasury is forecasting growth rates of 3.25 percent next year, which simply doesn’t look likely, especially on a day when Standard & Poor’s downgraded Greek debt to junk status, lowering their rating by three levels from BBB+ to BB+. Portugal’s credit rating was also cut two grades by S&P to A-, while bond yields rose in Ireland, Spain and Italy.

Without significant GDP growth, budget cuts of the magnitude described by all three parties would push the U.K. economy into a severe and long-lasting depression and cause much higher unemployment. That would inevitably mean lots more quantitative easing.

The question that needs to be asked in today’s debate is what each leader plans to do if their economic-growth projections are too high. Cuts and more cuts aren’t the answer. None of them really understands how bad things could yet become. Least of all Cameron.

(David G. Blanchflower, a former member of the Bank of England’s Monetary Policy Committee, is professor of economics at Dartmouth College and the University of Stirling. The opinions expressed are his own.)

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To contact the writer of this column: David Blanchflower at david.g.blanchflower@dartmouth.edu