Economic priorities of an incoming Tory government

July 22, 2009

richard-wellings-Richard Wellings is deputy editorial director at the Institute of Economic Affairs and editor of the IEA blog. The opinions expressed are his own.-

If the Conservatives are elected, as the polls currently predict, they will have to tackle the worst fiscal crisis in peacetime history.

At current spending levels, the government will have to raise around 200 billion pounds a year to fund a huge deficit that has spiralled out of control. Such high levels of borrowing will starve the private sector of investment.

There is also a real danger that the markets will eventually refuse to lend money in the absence of a realistic programme to pay off the debts. At the very least, investors in gilts may demand a larger risk premium. This would mean higher interest rates which would raise the cost of financing the debt, risking a debt spiral.

Tax rises, such as the planned 50 percent income tax rate for high earners, will not be sufficient to resolve the crisis. The income tax rise will perhaps raise a few hundred million pounds – maybe closing 1 percent of the gap. Tax increases will also damage the recovery by acting as a brake on entrepreneurship and investment.

The next government must therefore focus on cutting public spending if it is to create the conditions for a sustained economic recovery. And the scale of the cuts required to balance the books is beyond any historical precedent.

There are different estimates, and it depends on how badly the economy performs, but reductions of perhaps 150 billion pounds in annual public expenditure are probably necessary in order to put the public finances on a sound footing. This means losing almost one in four pounds spent by the government.

While relatively easy cuts – such as abandoning Crossrail, abolishing pointless quangos and cancelling urban regeneration schemes – are worthwhile, such tinkering at the edges will not be enough. The UK will have to consider emergency austerity measures, as seen in countries hit even harder by the current recession, such as Ireland, Iceland and Latvia.

Accordingly, the welfare state must be a key focus. An across the board cut in benefits and state pensions may be necessary. But the fiscal crisis could also provide the impetus for long-needed reform. Changes to tax credits and housing benefit – both of them hugely expensive and counter-productive – should be urgent priorities.

There is also huge scope for reducing the state’s role in education. Local Education Authorities could be abolished, cutting out a whole tier of bureaucracy from schooling. And further education, which tends to offer the taxpayer very poor value for money, could be cut back significantly without any negative economic impact.

A greater share of university funding could be shifted to the private sector. If education were funded directly through parents, much better education could be provided for less money. Real-terms funding could be fixed for a decade using a voucher system.

Unfortunately cutting health spending may be more difficult. Britain faces a significant demographic problem, with post-war baby boomers hitting retirement age, adding an additional burden to the already struggling NHS. Nevertheless, reform is desperately needed. One option would be a move to individual health savings accounts as operated successfully, and at low cost, in Singapore.

Such changes will face strong opposition from vested interests within privileged professions and long-established bureaucracies.

If elected as Prime Minister, David Cameron will therefore have to deal with perhaps the most challenging economic and political conditions since World War II. He should take inspiration from his predecessor Margaret Thatcher. The kind of resolve she showed in taking on the unions will be needed now to tackle a bloated and powerful public sector.

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