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Cameron May Need to Cut Spending More than Thatcher

Wednesday, 12 May 2010 | 7:12 AM ET

The Queen was made to hang around for 5 days this week while her elected representatives attempted to form Britain’s next government.

David Cameron
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David Cameron

After some of the most volatile coalition talks in the UK’s history, Conservative leader David Cameron finally made the short trip to Buckingham Palace to tell Her Majesty that he had formed an alliance with Nick Clegg’s Liberal Democrats that would allow him to form the next government.

But Cameron could be forgiven for asking himself Wednesday morning what he has let himself into.

Cutting the deficit is the big challenge. In 50 days we will have this government’s emergency budget, at which Cameron and his chancellor George Osborne will have to outline a credible plan to rein in spending.

Already we know 6 billion pounds ($8.9 billion) will be cut from the budget this year, but with the budget deficit running at more than 160 billion pounds, far bigger cuts will be needed to appease the market over the course of this parliament.

Cameron has agreed to attempt to take people earning less than 10,000 pounds a year out of the tax system and scarped plans to raise the inheritance tax threshold to 1 million pounds, in return for the Liberal Democrats dropping plans for a “mansion tax” on houses worth more than 2 million pounds.

More details will come soon, but the scale of the cuts will need to be huge, with many predicting Cameron has to make bigger cuts in spending than even Margaret Thatcher dared.

Given Cameron has pledged not to cut spending on the National Health Service (although Clegg sees huge waste in the system), it will be interesting to see which departments will see their spending power drastically cut.

What Will Be Cut?

With troops on the ground in Afghanistan and Cameron committed to a multi-billion pound investment in the new nuclear deterrent program Trident, it is unlikely there will be significant cuts in the defense budget.

Education has benefited from huge new spending under the Labour Party over the last 13 years. Whether or not that extra spending has improved the system is open to debate, but cutting in this area will be a political hot potato to say the least.

Cameron will be hoping plans to allow the private sector to set up schools will allow them to lower costs and raise standards. But the process will take time and teachers' unions are likely to bitterly oppose any cuts in funding for pupils and, crucially, into their wages.

Efficiency gains will be the buzz word around Westminster for years to come and expensive plans like ID cards and a national computer system for the NHS are set to lose funding.

Consultants like PwC, Accenture, IBM and KPMG will be losing out on billions in advisory fees if Cameron is to be believed, but there are big question marks over whether there is enough waste in the system to save tens of billions of pounds.

With spending on the police also difficult to cut, David Cameron and his coalition partner Nick Clegg are going to have to point their guns at the social security system; the right winger and the left winger are likely to have very different views on the merits of hitting the country's poorest in the pocket.

Telling the British it is time to think about their responsibilities in an attempt to rekindle the spirit of JFK in his first speech after taking power, Cameron is widely expected to take the knife to welfare payments and will be grappling with how to deal with Britain’s ageing population and its implications for the pension system.

Aaron Gurwitz, head of global investment strategy at Barclays Wealth, told CNBC.com that the rating agencies are demanding touch action on spending and will get it.

“I was positive that whoever won the election would be forced to cut spending aggressively and remain so now the election has been settled,” Gurwitz said.

Jochen Wermuth, managing partner at Wermuth Asset Management, believes all European governments have been lying to their voters by claiming there will be a pension for all when they get old.

“The coalition needs to tell the truth in this area and has the mandate to act,” Wermuth said.

Tax Rises to Follow?

Given the difficulties Cameron will face cutting spending, it is widely believed that taxes will have to rise.

If he is committed to taking those gaining less than 10,000 pounds out of the system, who picks up the bill will be closely watched. With Liberal Democrat Shadow Chancellor Vince Cable being put in charge of business and the banks, expect the City of London and the country's banking system to take a significant hit.

Cameron is also committed to raising the tax threshold to 50 percent for those earning over 150,000 pounds a year.

Debtor Nations
Debtor Nations

There are serious questions over how much revenue this will raise amid fears it could drive talent towards low tax countries in Asia and Europe; but whatever happens it will not raise enough money to significantly dent the deficit and appease the bond market.

What is really needed here are lower taxes, Wermuth said.

“Cutting taxes actually leads to higher tax revenues as less people leave the country or try and avoid taxes," he said. "A more competitive tax system would also attract top quality people and businesses to the UK.”

Throughout this election campaign, talk of reviving UK growth has been conspicuous by its absence.

European growth is flat at best and the real driver of the global economy is Chinese growth. Those countries lucky enough to be exporting raw materials to China like Brazil, Australia, Canada and the Middle East are growing strongly.

Germany and Japan are also benefiting from Chinese growth as their engineering and technology firms clean up meeting demand for goods that China desperately needs to maintain annual growth rates of 10 percent.

In the EU or Out?

Cameron's team has talked about the need to rekindle historic ties with Asia’s other major growth driver, India. It remains to be seen though whether anyone in the new coalition government has grasped the opportunities out there for a brave, externally focused Britain.

Wermuth believes the UK’s future has to lie within Europe, not outside. “With just 6 percent of the worlds population Europe today is the Netherlands of the world. The Netherlands is increasingly irrelevant within the EU and the EU is in a similar situation on the global stage,” he said.

Europe needs to become the Netherlands of the world, teaching its people multiple languages and acting as a melting pot of ideas for the world, Wermuth explained.

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

"Britain needs to get in the mix on Europe and start leading the bloc rather than allowing Germany and France to dictate its own future,” he said.

Britain already has a diversified economy with services and manufacturing that can compete on a global stage, Gurwitz told CNBC.com.

“Britain’s biggest resource is its people. This will not be a story about how all of Britain competes on the global stage, it will be 61 million different stories about competing on a global stage,” he said.

For all the doom and gloom around the UK at this point, I would draw readers to the fact that a country that can produce Monty Python and the ministry of silly walks will find a way to overcome whatever is thrown at it.

The problem is that no one ever expects the Spanish inquisition and it is difficult to gauge when the next crisis will again challenge Britain to stand up and be counted.

Contact Europe: Economy

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