Monday, February 14, 2011

Job Creation in the Private Sector

The government will be hoping that public spending cuts will make way for a larger private sector. There is an argument that shrinking the size of the public sector enables growth and job creation in the private sector. Furthermore the private sector is more efficient and should be able to create jobs faster than the public sector.

Since 2000, government spending as a % of GDP has increased from 35 % to 45%. Part of this is due to the recession, but it also part reflects increased government spending on the welfare budget and health care.

Arguments for Reducing Government Spending:

Crowding Out of Private Sector

Government borrowing can cause crowding out of the private sector. Firstly, if the government sell bonds to the private sector to finance its deficit, then the private sector are unable to use these savings for investing in private sector projects.

Secondly, if government borrowing appears to becoming unmanageable, markets will push up bond yields to compensate for the higher risk. These higher bond yields, push up interest rates in the rest of the economy and discourage private sector investment.

By reducing government spending, there may be a period of pain, but it also enables resources to be shifted from public to private sector. There is no reason why public sector jobs can't be replaced by new private sector enterprise.

Furthermore, some government spending can actually discourage productivity in the economy. If welfare benefits create a disincentive to work, then government spending could actually be encouraging a lower economic participation rate.

However, there are a few factors that need to be taken into account

Austerity creates climate of Pessimism.

I feel the government were over-enthusiastic in their scope and speed of cuts. By talking up how bad the economy was, they contributed to a decline in business and consumer confidence. This general pessimism does not create a climate conducive to private sector investment. If spending cuts had been less drastic and delayed for stronger growth, it would have been easier to absorb without adversely affecting general perceptions we face a double dip (or at least very slow growth). The private sector need stability, but the scale of spending cuts have created the opposite climate.

The enthusiasm for spending cuts, reminds me of the enthusiasm Mrs Thatcher had for tackling the money supply at all costs in 1980-1. At the Conservative party conference, she famously refused to do a U-Turn - great politics, perhaps, but you can't help feeling the 1981 recession was much deeper than necessary.

The irony is that 'bold' acts of public austerity, can prove much less helpful for reducing deficits than governments such as Ireland, Portugal and Spain are finding out.

Public Services.

There is a good argument to say that the private sector is more efficient for the majority of industry and business. However, this does not apply to public services with positive externalities. You may not agree with the necessity to subsidise rail, but private enterprise will generally fail to provide sufficient services such as education, training, infrastructure e.t.c. When councils fail to repair potholes in roads, it is the private sector who will face increased costs of car repair bills, slower journey times e.t.c. Spending cuts on vital public services lead to job losses, but the private sector will also suffer if the UK economy's infrastructure suffers lack of investment.

Crowding Out and Liquidity Trap.

Crowding out generally occurs when the economy is near full employment, but when the economy has spare capacity, crowding out is unlikely to occur - the government are essentially compensating for the fall in private sector spending.

Signs on the economic recovery are currently mixed. However, the low yields on UK government bonds suggests there is still reasonable demand for UK bonds. Private sector saving has increased since the recession. In this situation, of high private sector saving government borrowing doesn't cause crowding out because the private sector are preferring to save than invest.


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