Britain Winces as Cameron’s Government Wields Austerity Ax

U.K. Prime Minister David Cameron
U.K. Prime Minister David Cameron. Photographer: Chris Ratcliffe/Bloomberg

On June 5, the British paper the Observer ran a letter from 52 economists begging Prime Minister David Cameron and Chancellor of the Exchequer George Osborne to rethink their radical plan to lower government spending.

“Recent economic figures have shown that the government urgently needs to adopt a Plan B,” said the letter. Then came a rare bit of good news for the Prime Minister: an International Monetary Fund report urging Cameron and Osborne to stick to their plan. “Strong fiscal consolidation,” wrote the IMF, “remains essential to achieve a more sustainable budgetary position.”

The arguments over Cameron’s plan are getting heated as the Conservative-Liberal Democrat government presses on with the biggest budget squeeze since World War II, Bloomberg Businessweek reports in its June 13 edition.

The government envisions about 80 billion pounds ($131 billion) of spending cuts plus 30 billion pounds of tax increases over the next four years. Last year, when the cuts began, was the easiest to bear. Some 6 billion pounds in efficiencies were realized by the government in its various departments.

This year the measures intensify. Britons have already felt the pinch of a sales tax boost to 20 percent from 17.5 percent, which the Office for National Statistics says has added three-quarters of a point to the inflation rate, now at 4.5 percent.

Job Cuts

A two-year pay freeze for public-sector employees started in April, and cuts on welfare spending, including a three-year freeze in child benefit payments, are under way. A total of 310,000 government-funded jobs are to be wiped out by 2015; about 20,000 of those will be gone by the end of this year.

As the budget cuts unfolded, Sally Wheatman figured her days as a communications officer for the local government in Manchester, 163 miles north of the capital, were numbered. She volunteered to be laid off in April, and started a public-relations company with her payout.

While Wheatman said she’s “optimistic” about her prospects, she thinks “very carefully” before making big purchases, and all around her she sees people reflecting “long and hard” about their spending.

“I don’t get the sense that there’s a light at the end of the tunnel,” said Wheatman, 45. “When we saw how severe the cuts were, it started to dawn on us that things were going to change.”

Income Squeeze

There are already 2.5 million Britons out of work. As of March, the unemployment rate had held above 7.6 percent for 22 months. The possibility of a worsening job market is weighing on consumers, who are already seeing their incomes squeezed by rising prices for everything from food to car insurance.

VocaLink, which processes 90 percent of British salaries paid directly to bank accounts, says annual wage growth in the three months through May was 1.8 percent, less than half the inflation rate.

“Income isn’t keeping pace with inflation, which is making people nervous,” said Nick Moon, managing director of GfK NOP, which conducts consumer confidence surveys. “People aren’t going to be rushing out to spend.”

IMF Forecast

If consumers scale back spending, they could curb the recovery and deprive the Treasury of the tax receipts it needs to get the deficit under control. As it is, the economy stagnated over the last two quarters. The IMF lowered its 2011 growth forecast for Britain to 1.5 percent this week from a 1.7 percent projection in April.

Adding to consumers’ concern is the possibility of an interest-rate increase by the Bank of England.

“Consumer-spending growth is going to be sluggish at best,” said John Bason, finance director of London-based Associated British Foods, which owns the Primark chain of discount clothing stores. “If the authorities were to start tightening interest rates, that has to be negative for the U.K. consumer.”

The Bank of England left the key interest rate at a record-low 0.5 percent today. It’s been at that level for more than two years.

“They’re frightened that weak demand growth isn’t just a soft patch but something more sustained,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc in London and a former central bank official. “It’s become a really big deal.”

Inflation Threat

Nevertheless, the central bank also has to check accelerating inflation, caused by a weak pound that makes imports more expensive, commodity prices, and the increased sales tax. Andrew Sentance, who stepped down from the Monetary Policy Committee on May 31, has been campaigning to increase the benchmark rate to control inflation. Martin Weale, another committee member, and Spencer Dale, the bank’s chief economist, both sided with Sentance this year.

Cameron and Osborne have said they’re counting on the central bank to keep policy loose as they push government spending down to 40 percent of gross domestic product from 47 percent. Their plan calls for six consecutive years of spending cuts, a feat that eluded even former Tory Prime Minister Margaret Thatcher.

Deficit Projections

The government’s Office for Budget Responsibility forecasts that the deficit, which reached a record 11 percent of GDP in the aftermath of the recession, will narrow to 7.9 percent of GDP by March 2012.

So far, though, the efforts of Cameron and Osborne have not gained traction. Britain posted a 10 billion-pound budget deficit in April, the largest for the month since at least 1993, as tax income fell and spending rose.

That’s keeping pressure on Osborne, who only has to look 1,500 miles east to see how Greece is being punished by the bond market because of the perception that it’s wavering in its budget commitments.

“It’s very possible that U.K. growth will disappoint and tax revenue may be less than forecast and they may miss their fiscal targets,” said David Tinsley, an economist at National Australia Bank in London and a former central bank official. “The market will take a harsher view on signs they aren’t committed to meeting the cuts.”

Labor unions have voiced opposition to the cuts. The Public & Commercial Services Union, the largest civil service trade union, which represents about 300,000 workers, is balloting its members on a possible strike to protest the job cuts.

At a June 6 conference of the GMB, another major public-sector union, Business Secretary Vince Cable was heckled when he raised the possibility of government action to curtail strikes.

“Confidence is quite easy to lose but hard to get back,” GfK’s Moon said. For now, “people see themselves getting poorer.”

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