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.

Comments

I agree totally that an incoming government needs to make huge cuts to balance the books, and the candidate targets you have identified should all be considered. I am no socialist. But wait a minute – what about the other areas that right-wingers traditionally cherish, and consider ‘untouchable?’ What about halving the Trident replacement, Mr. Wellings? What about cutting the military? It’s too late to pull out of Afghanistan, but who knows whether America is about to make another enemy and drag Britain in once more at great cost? Under the justifiable pretext that France pays virtually nothing to the EU, we should also cut out the remaining billion or so that we pay. Although the current government is incompetent, what you forget, Mr. Wellings, is that the conservatives willingly supported many of their ludicrous money-wasting schemes, like ID cards and Iraq, for example. I have a horrible feeling an incoming Tory government would make cuts that would hit the poor massively but keep money-squandering schemes like the Trident replacement, an excessive military for the spent empire that we are, huge spending on nuclear power that will only worsen national security, and schemes like ID cards which only serve to preserve the Big Brother state we now live in.

Posted by nick | Report as abusive
 

Nick – you may be surprised, but in general I agree with your comments. I didn’t mention defence spending because it is a relatively small part of overall government expenditure, roughly a twentieth. Nevertheless, the fiscal crisis is so serious that big cuts will also be needed there, even if it means abandoning some cherished projects and international commitments.

ID cards should certainly be cancelled and I believe the Conservatives have already committed to this, if elected. It is difficult to think of a more wasteful and insidious government scheme.

Finally, nuclear power will require huge state guarantees and taxpayers will probably end up paying for construction cost overruns and/or future decommissioning. Electricity prices will also have to rise to subsidise this sector. Generators should be free to use whichever fuel they choose, with climate change addressed by other, more efficient means.

 

The biggest concern, and the one which the markets (which as you say, the next Government will need to keep onside) may most brutally punish, is the uncertainty about what a Conservative Government might actually do.

To be sure, nobody can complain if an Opposition plays its cards close to the chest. But this is not the problem here. Just this week we’ve seen new uncertainty over their policy on airport expansion. Somebody appears to be either mistaken, or lying, or leaking, and sadly, “mistaken” appears to be the least credible of the three.

Or social policy: after three years of “nudge” economics in which we’re told time and again that people can only be rewarded into behaving better, never punished into it, we’re suddenly told that bankers can only mend their ways by being punished, and that rewarding them was the problem, not the solution. Why are bankers different? Which other parts of society respond like bankers do?

Add to this a Conservative Minitruth rewriting history (well Wikipedia) for the pettiest of ends, and a leader who claims to see nothing wrong with parents lying in order to secure school places – and surely suddenly fiscal policy ought to be the least of their problems?

Posted by Ian Kemmish | Report as abusive
 

What will be the impact of such drastic 25% spending cuts on employment and consumer spending? Do you have an idea of how many surplus public sector employees would need to be let go? The economy and consumer sentiment is fragile and it is vital to avoid a deflationary tailspin right now.
Tax increases appear certain. If only we could impose a “Blair/Brown” tax surcharge on the Labour voters who last re-elected them despite clear evidence of what was happening! Let those who voted for “New” Labour foot the bill!
Part of the disaster is due to the middle classes falling for the Blairite siren call that they could feel good by voting for “fairness” and yet this would only cost them a little! It was never true and now we can see the consequences.

Posted by Martin Jones | Report as abusive
 

Martin – Current unsustainable levels of public spending are destroying jobs in the private sector, the productive part of the economy, by consuming resources that would otherwise be available to individuals and businesses. The prospect of hefty tax rises in the medium term also undermines confidence in the future of the UK economy and deters investment. Accordingly, cuts in government expenditure, though painful for those affected, are likely to promote recovery.

The level of inflation or deflation is largely determined by monetary policy and bank lending rather than fiscal policy. Nevertheless, large budget deficits may encourage politicians to inflate away the debt rather than make difficult cuts, risking 1970s-style stagflation.

 
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