Monday, October 4, 2010

George Osborne Economics

"...Imagine, if I were to stand up in the House of Commons in two weeks time and say: I’m cancelling the deficit plan. I agree with Ed Miliband. Let’s delay the tough decisions. Let’s borrow more. Let’s go on adding to our debt.

“Imagine if I said that. Now imagine what would follow. The market turmoil; the flight of investors; the dismay of business; the loss of confidence; the credit downgrade.”

He will add: “So Labour’s cuts wouldn’t be smaller. They would be bigger and last longer.
“In eight years time we would still be meeting here talking about what we would cut. A decade lost to debt." -

 George Osborne 4th October 2010

This is not necessarily the case see: Euro Mess for unwelcome precedents of austerity which causes bigger deficits and credit rating downgrades.

The kind of sentiment may strike a chord with the average voter. It seems to make sense, but is it justified from an economic perspective?

You could argue that rapid spending cuts now could push the economy into recession or much lower growth. If that is the case, the cyclical budget deficit will worsen. With lower growth it will be harder to reduce the debt to GDP ratio.

Zeal in tackling a budget deficit can make it more painful in the long run. Look at the example of Ireland. Stringent spending cuts earlier in the year. These cuts caused a fall in GDP and so have worsened the budget deficit. It has led to higher interest rates and a worse credit rating. Now, Ireland is being asked to cut spending again.

How did we reduce Post War Debt?

After the second world war, the UK had large deficit - much larger than today. The Labour government of 1945, didn't slash spending. In fact we increased spending on the new NHS and new welfare state. Debt to GDP was reduced over time through economic expansion. It is economic expansion which is the best way to reduce debt to GDP in the long term.

The IMF admits, in a recent publication MACROECONOMIC EFFECTS OF FISCAL CONSOLIDATION that fiscal tightening in Northern Europe is likely to depress European economies for the foreseeable future. (Telegraph link)


Unknown said...

interesting point but can you use the same argument? During the war the economy had been focused on the war effort and so had lots of scope for development into consumerism post war. Is there any big changes this time around that can lead the economy to expand in a big enough way? interested to hear your thoughts on this. been following the blog for a while and its really helped in with my studies.


Basudeb Sen said...

The debt to GDP ratio is cut not by reducing debt but by expansion of GDP. Absolutely correct. But the Governments do not really know how to make the GDP grow faster than the debt. They just hope that they can bring GDP expansion by sending and deficit: that's the only thing the govts. know: spend - in times of depression to get out of it and in times of expansion and booms to spend to enjoy the benefits of expansion and boom. The GDP however responds to what the private sector does and not what the Govt. does.

Anonymous said...

Agree with Samuel- unless there's a clear route for private sector expansion then how can we "grow our way out"?

Personally- I accept your arguments, but what alternatives can you present?

I certainly agree that we have to adapt any austerity package as the numbers change, but I also think that the sooner the deficit is (safely) dealt with, the better.