June 22 (Bloomberg) -- The U.K.’s bet on “draconian” spending cuts and some tax increases will slow growth in real income and may reverse the nation’s economic recovery, according to David Blanchflower, a former Bank of England policy maker.
Chancellor of the Exchequer George Osborne announced today a 25 percent cut in spending over the next four years, excluding overseas aid and the National Health Service. The move will depress revenue essential for growth, Blanchflower said in a radio interview on “Bloomberg Surveillance” with Tom Keene.
“These are absolutely draconian spending cuts,” said Blanchflower, 58, a Dartmouth College economics professor who was on the Bank of England’s Monetary Policy Committee from 2006 to 2009. “This is going to pull a huge amount of money out of the economy, and it’s really one of the biggest gambles a chancellor of the exchequer has ever done.”
Conservative Prime Minister David Cameron’s government will impose a levy on banks and raise the sales tax in the biggest budget-deficit cuts in a generation, seeking to guard the nation’s top credit rating without stifling economic recovery.
The government is betting that the private sector will step in as the public sector pulls out, which Blanchflower said won’t happen. Stimulus measures, an “automatic stabilizer,” should be eased when the economy has fully recovered, according to Blanchflower.
“The danger is you take it off in the bust and you make the bust worse -- that’s exactly what I think is going to happen here,” Blanchflower said. “The evidence on growth in the U.K. is pretty anemic. The European area seems to be slowing, and it looks to me like most of it’s being driven by the stimulus.”
Osborne, 39, the youngest chancellor since 1886, is aiming to reduce a deficit that reached 11 percent of gross domestic product in the last fiscal year.
The U.K.’s spending will be cut by 30 billion pounds ($44.4 billion) a year, including 11 billion pounds from welfare. The increase in the value-added tax to 20 percent in January from 17.5 percent is projected by the government to yield 13 billion pounds a year by 2015.
From April 2011, the corporation tax will fall by 1 percentage point each year over the next four years, taking the rate to 24 percent in 2014. The rate for small companies will fall to 20 percent in 2011 from 21 percent.
While Fitch Ratings said today that the budget is a “strong statement of intent” to accelerate deficit reduction and cut public debt, Blanchflower said rising unemployment and falling output will pose problems.
The two-year freeze on public workers’ pay and a wave of job cuts in the public sector that Osborne announced will hurt consumers and push them to save more, slowing growth further, according to Blanchflower.
“It’s hard to see where wage increases come from, and it’s hard to see where real incomes rise,” he said. “Of course, the whole thing depends on the people spending again, and it’s hard to think that in this austerity period, people are going to do anything but save like mad, so this is a big worry.”
Osborne said unemployment will peak at 8.1 percent this year before falling to 6.1 percent in 2015. He lowered growth forecasts to 1.2 percent this year and 2.3 percent in 2011.
The U.K. can test austerity as the U.S. government’s economic stimulus works its way through the system, according to Blanchflower.
America “has actually got it right,” he said. “You keep going as long as you can and let the private sector strengthen and take up the slack. But you withdraw at your peril. This is going to be one of the biggest experiments, and the U.S. can sit and watch and look and see what happens to the U.K. output data, which I suspect is about to collapse.”
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