IHS Global Insight Perspective | |
Significance | The U.K. chancellor (finance minister) yesterday unveiled his long-awaited spending review, outlining cuts of around 19% for each department over the next four years. |
Implications | The government has largely stuck to its public spending targets set out in June's emergency budget. Nonetheless, the scale of the cuts is likely to deal a blow to the coalition's popularity in the medium term at least. |
Outlook | The government has presented a strong case for the cuts, placing reductions in the United Kingdom's soaring fiscal deficit as its top priority. However, with nearly half a million jobs likely to be lost over the next four years as a result of the review, tough times lie ahead for the U.K. economy. |
Conservative chancellor (finance minister) George Osborne yesterday unveiled details of £81 billion (US$128 billion) in U.K. spending cuts over the next four years. In a speech to parliament, Osborne revealed cuts to public spending designed to reduce costs in government departments by an average of 19%, as well as an increase in the retirement age to 66 by 2020 and the elimination of almost half a million public-sector jobs over the next four years. In addition, Osborne revealed that the temporary tax on bank balance sheets will be made permanent, which the chancellor hopes will raise £2 billion a year. The motivation behind the spending review is to bring down the United Kingdom's inflated fiscal deficit, which currently stands at around 11.5% of GDP. Osborne stuck to the public spending targets set out in the June emergency budget: current expenditure is forecast to rise from £637 billion in 2010/11 to £651 billion in 2011/12 and £693 billion in 2014/15. This is aimed at bringing current expenditure back down to 38.4% of GDP in 2014/15 after spiking up to an expected 43.2% of GDP in 2010/11 from 37.8% of GDP in 2007/08 and a low of 34.5% of GDP in 1999/2000. The capital expenditure budget is being raised by some £2 billion a year from the figure set out in June, but even so it will fall from £59.5 billion in 2010/11 to £50.7 billion in 2011/12 and £45.6 billion in 2013/14 before rising to £47.1 billion in 2014/15.
Department Cuts
Spending in only three government departments has been ringfenced, meaning that healthcare, foreign aid, and schools spending will not undergo the harsh cuts envisaged for all other sectors. When originally announced, Osborne had warned that departments would be facing spending reductions of 25% over the next four years, but this has fallen to an average of 19% after the chancellor revealed an extra £7 billion a year in welfare savings on top of the £11 billion that was announced in the emergencey budget, since benefits to the long-term unemployed will be cut if they fail to seek jobs. In a bid to rebalance the U.K. welfare system to weigh it firmly in favour of work, there will be a cap on the total benefits paid to families as the government looks to ensure that nobody will be better off by not working, assuming that they are fit and able to do so.
Some departments are facing cuts of much more than 19%, including the Home Office, Foreign Office, and Ministry of Justice. In addition, funding to local government will fall by 7.1% a year over four years. However, certain infrastructure programmes—such as high-speed rail links between London and the north and Crossrail (linking east and west London)—have been preserved and will go ahead as planned.
Job Losses and Retirement
The chancellor confirmed that 490,000 public-sector jobs—8% of the total number of workers employed by the state—are expected to be lost over the next four years as a result of the spending cuts. IHS Global Insight doubts that the private sector will be able to fully compensate for this. Indeed, we suspect that firms will become increasingly cautious in their employment plans, reflecting slower growth and concerns that the intensified fiscal squeeze will hold back economic activity for an extended period. There are also likely to be significant job losses in private companies supplying services or goods to the public sector. Consequently, we suspect that unemployment on the International Labour Organization (ILO) measure could reach a peak of 2.85 million in 2012, with the jobless rate reaching 9.0%.
In addition to the job losses, the chancellor revealed that the retirement age will go up by one year to 66 by 2020, four years earlier than planned. The expedited increase is expected to save the U.K. economy £5 billion.
Outlook and Implications
Since coming to power in May, the government has been issuing sober warnings of the need to purse fiscal deficit reduction through wide-ranging spending cuts. Osborne's speech yesterday was simply the culmination of this public relations campaign, which has proven relatively successful in making the U.K. public aware of the precarious state of public finances, as well as the need for sacrifices at all levels. Nonetheless, the spending review is a gamble for the Conservative-Liberal Democrat government since the public has yet to feel the impact of the planned cuts. In addition, the planned cuts will be completed by the start of campaigning for the next general election in 2015. The Conservatives and Liberal Democrats will be hoping that the cuts now will allow them to fight for re-election against a background of robust growth and economic prosperity.
There is also a gamble on the economic front. The major spending cuts will undeniably weigh down on economic growth and there are serious concerns that it could derail an already fragile U.K. recovery. This is a risk that the coalition government clearly believes is worth taking, as it argues that the longer-term risks to the economy of not taking strong corrective fiscal action are even greater. In particular, the government has highlighted the drain on the economy from the higher interest payments that come from higher government debt levels, stressing that this is a major waste of taxpayers' money. There is also the danger that investors' confidence in the U.K. economy will be undermined if the AAA rating is lost. In the ideal scenario, the private sector would absorb the major impact of the cutbacks, stimulating stronger growth and helping the United Kingdom emerge from the economic and fiscal problems it has experienced over the past two years.
Perfectly reasonable cases can be made for both pressing ahead with the spending cuts at the current rate and slowing them down, as is evident by the intense debate that continues to rage among politicians, economists, and other analysts. Only time will tell who is right. Moreover, much could yet depend on the general state of the global economy over the next couple of years. The better this is, the greater the chance that the U.K. recovery can survive the fiscal pain intact. However, if the global economy suffers serious problems over the next couple of years, then the U.K. economy could struggle terribly.
We do not expect the spending cuts to push the United Kingdom into a "double dip" recession. However, we do expect growth to be muted for an extended period, although this reflects other factors in addition to the spending cuts, such as high consumer debt levels, ongoing tight credit conditions, and sluggish global growth.