Moorad Choudhry on Britain's Only Credible Option
It appears that 52 economists have urged the UK government to abandon the public spending cuts associated with its “Plan A” and move to a Plan B, which would involve halting the cuts and…not much else, it would seem.
UK monetary policy is already very loose, and to suggest that public spending should increase when the budget deficit is already large and rating agencies are again putting the UK on negative watch, is not tenable.
The IMF (International Monetary Fund) weighed in this week with qualified support for Plan A, saying that the government may need to consider further quantitative easing (QE) if the economy does not pick up.
The argument in favour of Plan B is persuasive if one considers only the economic statistics.
The UK economy has been essentially stagnant in 2011 and is struggling to emerge from recession (a similar picture can be observed in the southern euro zone).
Enforcing spending cuts can only hurt a still-weak economy, and will do nothing to alleviate the employment situation. However, Plan B is not really an option.
Continued borrowing to maintain, let alone increase, public expenditure is no guarantee of rapid improvement in the economy either.
It would also risk placing the UK at the mercy of the markets as is currently being experienced by the southern euro zone.
The credit rating agencies have suggested that the UK’s sovereign ‘AAA’ rating is at risk if there is no credible plan to bring public spending under control, and if the rating was downgraded, it would hit the government exactly where it can’t afford to take the pain: in the fiscal pocket, as borrowing costs would become considerably higher.
That said, we need something more coherent than spending cuts, crossed fingers and hopes for an economic rebound.
We need a more comprehensive Plan A.
Cutting spending is a sensible thing to do after years of borrowing beyond one’s means.
At the same time, the high level of unemployment is a serious drag on growth: a double whammy of lost output and high welfare expenditure (youth unemployment at 1 million in the 16-24 age range, is a particular tragedy for social as well as economic reasons).
Cuts in social welfare are painful but understandable, but targeting unemployment must be the main priority for the government.
Otherwise, all Plan A becomes is a budgeting exercise - condemning the UK to languish in 0% GDP growth for the remainder of the year.
Echoing 1980s-style monetarists, Plan A also needs to include “supply side” reforms, designed to make life easier for businesses.
It should include tax concessions, but not cuts in income or consumer tax (the government couldn’t afford that anyway), but cuts to payroll taxes.
An employer tax cut for any youth or long-term unemployed hired, would be a good start.
There is a wide range of these kind of measures that can be made to make it easier, and cheaper, for businesses to hire more staff, and which can incentivise them to recruit in areas with high unemployment.
It appears the government is looking to offer cash incentives to small businesses for hiring within certain categories. However, paradoxically, this is not the most effective way to address this issue as it is only a short-term measure.
A one-off bonus is just that: less of an incentive than a simplification of and/or cut in employer taxes, which would have a much longer-term impact.
There is a similar issue in theUS economy, where the two biggest factors continuing to act as a drag on growth are the fall-out from the real-estate crash and the high level of unemployment.
This week Fed chairman Mr Ben Bernanke noted the slowdown in the US economy, which led to speculation that a third round of QE may be on the cards in 2012.
Certainly US interest rates are not expected to increase above the current zero level until the third or fourth quarter next year at the earliest.
Private sector job creation on the other side of the Atlantic has also been almost as disappointing as it has been in the EU in the last two years.
For the UK, Plan A remains the only credible game in town, but for it to work properly it needs a strong element of labour market supply side reforms.
Reducing unemployment lowers the welfare bill, which makes the spending cuts easier to implement.
It also means that Plan A is a bit more proactive and is less at risk from the impact of external events, which can negatively influence government spending plans.
Dr Moorad Choudhry is Head of Business Treasury, Global Banking & Markets, Royal Bank of Scotland, and Visiting Professor at London Metropolitan University.