Tuesday, January 25, 2011

Spending Cuts Hurt

It seems all around me, friends and family are being affected by government spending cuts. If not directly affected, you can't avoid local paper headlines along the lines of 'investment in train lines shelved due to cuts'

Back when they were announced, I opposed the scale and timing of spending cuts on the grounds that:
  • Spending cuts would hurt growth, cause more unemployment and increase the cyclical budget deficit.
  • The UK bond market was not on the verge of collapse (UK situation different to Ireland and Spain, constrained by Euro) But, anyway austerity measures have an unfortunate habit of not solving deficit problems - if the spending cuts cause lower growth. (Savings and Austerity)
We now face forecasts of economic growth for 2011 which barely remain positive. There is also a decline in confidence as people absorb the implications of spending cuts. The Markit Household Finance Index shows a sharp rise in the number of households (34 per cent) expecting their finances to worsen over the coming year. This is the worst level since Jan 2009.

Insolvency firm, Begbies Traynor, suggest 147,836 companies got into payment difficulties last year. The number of corporate insolvencies in 2011, could rise to 23,500.

Also as the spending cuts bite, it gets worse. Not only is there the pain of job losses, and lower growth, there is also the negative long term impact on desirable public sector investment.

We are told we have no money to fill in potholes. What this means is that we will pay for it through increased repair bills and councils getting sued for failing to meet safety requirements.

Filling in potholes is exactly the kind of thing we need the government to be doing. These spending cuts not only hurt aggregate demand, but also aggregate supply and the future productive capacity of the economy.

It's still not too late to reverse these spending cuts. Keeping investment in trains, roads, education and health care, would be helpful, despite the high level of public sector debt.

Unfortunately, it would be harder to change people's expectations which have largely absorbed the prospect of spending cuts. But, it needn't be this painful.

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