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Andrew Haldenby is director of the think-tank Reform, which today publishes a report,
The hole we are in and how to get out of it, presenting new evidence that a fiscal stimulus – whether tax reductions or spending increases – will prolong the recession. This, he says, is worrying since the Government is expected to announce just such a package in the Pre-Budget Report next week.

The Chancellor wants to introduce a stimulus to give the electorate the confidence to increase consumption.  But the overwhelming academic evidence is that what actually restores confidence is a sense that governments have regained control of their finances.  This is why many economies – including the UK in the early 1980s – had the paradoxical experience of a return to growth after tax increases.

This is also why fiscal stimuli in the form of crisis tax cuts don’t work.  Either the electorate will discount them because they know the money has to be paid back in higher taxes.  Or – this is the view of the academic authority, Stephen Ceccheti – governments will avoid the higher taxes and the public finances will get even further out of balance.

Reform’s Consultant Director, Nick Bosanquet, points out that the Government has misread Keynes.  Keynes actually focused on confidence; a true Keynesian position would be about measures to raise confidence and demand in the private sector.  Instead we have what he calls “Toxic Keynesianism” – the view that what we need is big government spending programmes which will beat unemployment and further increase the role of the state.

Our report is also about honesty.  The Prime Minister and the Chancellor have said that the public finances can withstand a burst of extra borrowing.  In fact the UK has the fourth highest structural budget deficit in the OECD.  Including the Government’s long term spending commitments on pensions and education, the deficit stands at 6.6 per cent of GDP.  Without changes in spending, that means eventual tax rises of £100 billion, or £4,000 per household, which would wipe out over a quarter of families’ disposable income.

Please don’t believe the Treasury’s estimates on borrowing in Monday’s report.  In the last five years, it has underestimated the true level of borrowing by a total of £121 billion.

And it’s about culture.  In retrospect the UK has endured a long period
of living beyond its means, supported by interest rates held far too
low.  We have become used to unsustainable levels of debt and
consumption (we use the graphic image of the “obese economy”).  We now
need to find a new path based amongst other things on saving (remember
that?).  A fiscal stimulus would be the last hurrah of the debt-binge
era.  It’s time to move on.

Instead the Chancellor should get a grip of public spending.  That does
not mean crisis cuts in public spending, which would increase
inefficiency and – by creating a perception of under-funding – lead to
demands for higher spending later on.  This, by the way, was the story
of the 1990s.  Crisis (Conservative) spending cuts led to a popular
demand for (Labour) spending increases.  The UK public sector needs to
leave behind this cycle of boom and bust.

Instead it means the programme of public service reform that the
Government should have introduced years ago.  The recession should give
the Government the courage to tackle the root causes of inefficiency.
Above all that means the workforce agreements with public sector
workers and the political direction from Whitehall.

Much of the programme will save money immediately.  We can’t
underestimate how much of the inefficiency of public spending is due to
the targetry and tinkering to which most Ministers and senior officials
remain addicted.  A typical finding of our research is that the leaders
of public services have the tools to change the way their services are
run but are continually distracted by political priorities, from
hospital cleanliness to changes to school curricula to ever-changing
rules on use of police resources. The only cost of putting targets on a
bonfire would be a certain amount of Ministerial embarrassment.  The
gains would be immediate and large – even if for example the NHS became
only 5 per cent more efficient (and it would be much more), that would
save over £25 billion during a Parliament.

The Chancellor can also set out a productivity agenda for the private
sector and individuals.  We suggest greater competition between
businesses – the Lloyds / HBOS merger is ill-omened – and
deregulation.  We should also enable individuals to make better use of
their own money.  Public sector reform should open up the room for
sustainable reductions in marginal tax rates, improving productivity.

In the short term, the automatic stabilisers have to be allowed to work
and overall public spending will rise due to higher benefit payments.
At the same time, the Government must reform the rest of public
spending.  We suggest that the Chancellor should revise his
Comprehensive Spending Review and republish it with the March Budget.
When the Chancellor drew up his last spending forecast, he expected
growth of 2.75 per cent in 2009.  It will actually be less than minus 1
per cent.  His proposals for spending (excepting the automatic
stabilisers) need to be revised downwards.

The Conservative Party’s new policy on public spending therefore looks
well-judged and well supported by the evidence.  The danger of
excessive borrowing is real.

The remaining challenge is over public service reform.  We read that
the Conservative Party is looking for “waste” to justify reductions in
public spending (rather like the James Review in the last Parliament).
That isn’t good enough – the problem isn’t “waste” but the structures
that lead to the waste.  There is no avoiding the need to tackle
head-on factors like the terms and conditions of public sector
workers.  There is also no avoiding the NHS – it’s the biggest budget
(£100 billion) and can’t just be appeased.

The Conservatives faced down union opposition in the early 1980s
recession, to the great benefit of the economy.  Will they find the
courage to repeat their achievement in today’s recession, in the public
sector?

Next year the recession will bite hard.  Policy makers will be
confronted with unemployment and public finance figures that keep on
getting worse and worse.  Further damage to the public finances will be
recognised to be highly irresponsible.  I hope Alistair Darling will
reconsider.

32 comments for: Andrew Haldenby: Fiscal stimulus will prolong the recession

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