Allister Heath

Savage cuts are the safer option

If John Maynard Keynes were alive today, he would be appalled at the disastrous state of our public finances.

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If John Maynard Keynes were alive today, he would be appalled at the disastrous state of our public finances. He is loved and hated in equal measure as the man who made pump-priming during downturns intellectually respectable. But nothing he ever wrote could be used to justify the scandalous mess in which Gordon Brown has landed Britain.

Not only has Keynes been body-snatched by advocates of big state spending, but he finds himself in the battleground for the next general election. At Labour’s conference next week, the Prime Minister will say that Labour must be re-elected precisely because it will cut spending by less than the Tories. David Cameron’s attempt to reduce the fiscal deficit more quickly, he will argue, will tip the economy into a new recession. This will be Labour’s war-cry from now on.

Mr Brown’s agenda is fairly straight-forward. Next year, according to the OECD, state spending in Britain will reach 55 per cent of national income — up from 38 per cent ten years ago. This crucial statistic has been largely overlooked; yet it demonstrates that almost an extra fifth of our economy has come under state control on Labour’s watch. It is, from Brown’s perspective, a major accomplishment. It has reshaped the British economy in the mould of traditionally socialist states like France and Sweden.

So should spending stay at such levels, as Labour suggests? Or should more radical action be taken? Let us consider Brown’s main claim: that Britain would fall back into recession if the Tories were to cut state spending at a faster rate than Labour intends.

There is, of course, a risk that this will happen. But there is a far greater chance of a new recession — one just as violent as last year’s crisis — if spending is kept at current levels. Paradoxically, the only way to prevent this double dip is to cut spending, but do it by phasing in reductions in a sensible way.

The alternative — to keep spending high, as the government proposes — is freighted with risks. The Bank of England will soon stop its quantitative easing programme, which is, in effect, printing money to buy government debt. This will remove a massive distortion in the debt market, and will likely prompt investment funds to buy far more UK government stock. This will leave less money for them to lend to private firms — thereby threatening the supply of credit needed for economic recovery.

Next, if investors are nervous about government borrowing, they may demand higher interest rates. This would have a ripple effect throughout the economy, increasing everybody else’s borrowing costs and dealing a second blow to struggling companies.

If growth does return, the continuing high deficit would soon become inflationary — demanding a response from the Bank of England which is most likely to take the form of higher interest rates. And that, of course, could precipitate another house price crash and a second downturn.

Consumers are preparing for tougher times by repaying their own debt. The growing sense that ‘savage cuts’ are on the way (they have already arrived in Ireland) is feeding a sense of foreboding. When a pull-back in state spending is expected, pump-priming stops working. In this way, state spending begins to hinder demand, because a worried private sector cuts back its spending even faster than the government is able to borrow. We are at that stage now. This is why cuts are vital to avoid a new recession.

It is also said that Britain is a low-debt country — which was true when Brown became Prime Minister: net debt was 37 per cent of national income. It is now 57 per cent, and many forecasters talk about 100 per cent. Those who are relaxed about this figure — Will Hutton and his ilk on the left — argue that Britain’s national debt peaked at 250 per cent after the second world war. We recovered from that, they argue, so why the anxiety?

First, because the markets simply will not tolerate so much borrowing this time round. Why lend to a Britain which still, even now, has no published plan to reduce national debt? It’s worth remembering that Britain had to call in the IMF in the 1970s with a far smaller deficit. Also, there is nothing abstract about debt interest payments, which have already overtaken the budgets for defence and schools. Debt interest payments are forecast by the Treasury to rise by £16 billion next year alone — the financial equivalent of six more Afghanistan wars.

This is why, on balance, not cutting spending more sharply — the Labour proposition — is the riskier of the two cutting options. If there is any lesson to be drawn from the last dozen years, it is that to borrow one’s way out of trouble guarantees an even bigger reckoning. Cuts will not be easy or painless. But to acquire a wartime-scale national debt, as Labour now intends, threatens a different kind of maelstrom from which the British economy will take far longer to emerge.