Continuing down the path of austerity while ignoring straightforward - if politically difficult - solutions, will lead the UK closer to economic disaster
Austerity Does Not Work
All our major political parties are committed to reducing the government deficit in the next parliament, but with our economy remaining as unbalanced as it is at present, there is very little chance that they will be successful.
The UK government deficit is one of the largest in the developed world – in 2014 it was only a little short of £100bn. At the end of 2013, gross government debt was 91 per cent of GDP, and once the figures are released, it will probably show about 94 per cent at the end of 2014.
If the rate at which the debt is accumulating continues as it is, it will go on rising at the rate of about three per cent of GDP per annum. This means that within 10 years, total government debt would be about 125 per cent of GDP, and heading to levels which are completely unsustainable
Austerity will only increase the downward spiral
For too long our political leaders have focused on reducing spending and raising taxes in order to tackle the deficit. Politicians, the civil service, the commentariat and the academic world all see this as the only solution. This view is, however, based on a fallacy of composition which fatally undermines its efficacy. What might well be sensible for an individual who is over-spending, and which has no measurable impact on the economy as a whole, does not work for the government which is a major player.
In our new book,‘Call to Action: Britain’s Economic Problems And How They Can Be Solved’, which is being launched on 16 March 2015, former Labour shadow minister Bryan Gould and I explain why we believe that continuing down the path of austerity while ignoring straightforward even if politically difficult solutions, will lead the UK closer towards economic disaster.
Lack of demand cannot be tackled with austerity
The reason why we have a large government deficit is mainly because we have a very substantial balance of payments shortfall, currently running at about £100bn per annum (£). This sucks demand out of the economy which has somehow to be replaced if the consequent lack of purchasing power is not going to cause our GDP to fall. It is the government deficit which stops this happening.
There are three, and only three, ways in which this lack of demand can be made up other than by the government. It can be replaced by households spending more than their incomes, the corporate sector spending more on investment than its retained profits or the government running a deficit.
Currently, there is a small amount of net borrowing by households coupled with an only slightly larger amount of net spending on investment by the corporate sector, leading to the government deficit being more or less exactly equal to our balance of payments deficit.
To get the government deficit down, therefore, requires either a large increase in consumer borrowing, a dramatic rise in business investment or a major reduction in our balance of payments deficit. Unfortunately, cuts in government spending or increases in taxation will not cause any of these things to happen.
The inevitable result will be that the government deficit will stay about the same size as it was before, or maybe become even larger, while the deflationary impact of government cuts will be to make GDP fall.
The outcome of austerity policies, therefore, is that we finish up in the worst of all worlds with falling GDP but still rising government debt, with an even weaker economy to service it than we had before. As the economy falters, welfare expenditure goes up and tax receipts fall.
The only solution is to get the exchange rate down
What can, therefore, be done to get the government deficit down? There is only one solution which will work and this is to tackle the balance of payments deficit. If this can be substantially reduced, the problem with the government deficit will disappear.
In order to reduce the balance of payments deficit we have to sell much more to the rest of the world than we do now. And since most world trade is manufacturing, we will have to sell more manufactured goods. To do this, we will need to get the proportion of our GDP which comes from manufacturing up from about 10 per cent, where it is now, to around 15 per cent.
There is only one way to get this done. We need to get the exchange rate down to a level which makes it possible for the UK to produce enough manufacturers to pay our way in the world again. It is no good our trying to rely only on high tech production. We will never produce enough of it. To sell a sufficient amount abroad to get our foreign payments back in balance, we need to be able to produce much more price sensitive low tech products as well. This is why we need a much lower exchange rate.
John Mills is an economist and chairman of consumer goods brand JML. He served as a Labour councillor almost continuously between 1971 and 2006, and his latest book, ‘Call To Action,’ is being launched at the RSA at 6.30pm on Monday 16 March. Admission is free, and you can register online: http://call-to-action.org.uk
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