Wednesday, June 23, 2010

The UK's "kill or cure" budget

George Osborne, the UK Chancellor (or Finance Minister) has asked that his first Budget be judged by two yardsticks: its success in reducing the deficit and the proof it offered to the nation that “we are all in this together”.

By the second yardstick, he will certainly fall short because it is widely acknowledged that his budget will disproportionately affect the poor and advantage the rich.

Whether he will be successful in the first (reducing the deficit) remains to be seen. The budget savagely cuts public spending, with most government departments threatened with a 25 per cent by 2014-15. Now that the government accounts for as much as 48% of GDP, that may slash perhaps as few as 50 thousand jobs or – depending on developments – overall unemployment rising as high as 3 million. The budget has welfare reductions and tax increases that grows every year until it hits £40bn in 2014-15. Briefly, this is one of the most drastic spending squeezes in any advanced economy since World War II.

In addition, consumption taxes will be raised (VAT will go up from next January to 20 per cent). That amounts to a UKP 5000 hit for the average family in the UK – though of course any flat tax hurts the poor much more than the rich.

On the other hand, income tax allowances will rise by £1,000 (taking an estimated 880,000 people out of the income tax system - though how many of them will still be in jobs is not clear), the basic state pension will increase in line with earnings from 2011, and £2bn will be spent on children in the poorest families.

Then there is the £2bn tax on banks, which will give him some additional income but I wonder if that will not further constrain the principal growth engine of the UK economy (financial services).

Oh and I should mention some measly measures that the Chancellor has taken which are meant to encourage small businesses.

As Mr Osborne is reported to have said: “Our policy is to raise from the ruins of an economy built on debt a new, balanced economy where we save, invest and export”. Saving and investing might perhaps be possible (though it is difficult to see how that will be within the reach of most people in the UK). What we can definitely say is that export will be a chimera, because the UK really manufactures very little and most of its professional services (which form the bulk of its exports) may be in less demand if one considers that the reputation of professional services derives partly from the overall success of the economy of which it is a part.

So will this budget signal “the start of a period of painfully slow growth, falling living standards, and prolonged high unemployment” (in the words of one commentator) or whether what we have is a "a reckless budget that pulls the rug out from under the economy” (as Harriet Harman, the acting Opposition Leader put it)?

At its best, it is an optimistic budget which leans heavily on inflation and interest rates remaining low – which is probably unrealistic given the volatility of the world economy.

The key matter is whether the budget can prevent a bond market crisis. In other words, it is not governments, nor is it voters, but rather bond market traders, who will eventuallydetermine whether or not the budget will be a success eventually – and that reaction will be based on the bond markets evaluation of whether the UK can create a successful recovery, which in turn depends at least partly on how the whole of the UK responds to the cuts and increased taxes.

Champagne, folks? Or Molotovs? Sphere: Related Content

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