Dissecting the cuts

In advance of next week’s government spending review Capital Economics has provided an exemplary analysis* of the prospects for cuts.

Jonathan Loynes, the economic consultancy’s chief European economist, is scrupulous in avoiding taking sides with either the government or opposition. Instead he breaks down the likely impact of cuts under different scenarios.

His first target is the peculiar claim made by some that the government’s spending plans do not really constitute “cuts”. This is based on the observation that in nominal terms total spending will continue to rise. Loynes points out that in relation to the indicators that matter, inflation-adjusted spending or as a share of GDP, there will be sharp falls in spending.

Once the areas the government cannot control are taken into account the remaining cuts could be 20% in real terms and even twice as much in some ministries. Not only the ring-fenced departments, where the government has pledged not to make cuts, but also debt interest and social security are beyond easy government influence. (article continues below)

The cuts are therefore likely to be painful. Unemployment in particular looks set to rise sharply.

“If Capital Economics is right in its analysis, and it is hard to fault, the coming years look set to be tough”

According to Loynes the key factor determining just how severe they will be both is and should be the state of the broader economy. If growth is strong the cuts will be easier to bear. But if, as looks likely, it is weaker than expected then the outlook will be even more painful.

For a long time the economy has relied on high public spending for support. However, it looks likely that the private sector will find it difficult to compensate for the reduction in state spending.

If Capital Economics is right in its analysis, and it is hard to fault, the coming years look set to be tough. Spending cuts are not going to be achieved by the easy elimination of plentiful “waste” and the private sector will not suddenly flourish once deprived of state largesse.

Of course if there was a political party committed to achieving dynamic growth the outlook could be wholly different.

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* “Can the spending cuts actually be achieved?” UK Economics Focus. October 14, 2010.