Sunday, August 08, 2010
Confidence battered by bloodcurdling talk
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My Sunday article is available to subscribers on - this is an excerpt.

Nerves are jangling, reflected in a drop in both consumer snd business confidence. The latest purchasing managers’ index from the services sector shows that, while it is still expanding, business expectations have suffered a fall of around 10 percentage points since the spring.

There has been a similar drop in consumer confidence, as monitored by GfK NOP for the European Commission. It has dropped by eight points from pre-election levels even as, on official figures, the economy has picked up speed and unemployment fallen.

Why might this be? Markit, which produces the purchasing managers’ index (it measures business to business activity in the sector) puts the blame squarely on the government

“Behind the weaker growth profile for the service sector is a failure of confidence to rebound from the record fall seen in the aftermath of the emergency budget,” said Paul Smith, an economist with Markit. “Expectations about prospects for the coming year appear to have down-shifted in response to the austerity measures announced in June.”

The drop in consumer confidence appears to have similar causes. Talk of austerity has dominated the coalition government’s short life, both before and since the June 22 budget.

Next, the clothing retailer, reported a “noticeable cooling” of demand since early May, when David Cameron and Nick Clegg strode into Downing Street, not quite hand in hand.

In general, despite one or two wobbles, the coalition has done very well. Compared with the warnings about the dangers of a hung parliament ahead of the election, and all that nonsense from Pimco about Britain sitting on a bed of nitroglycerine, things have been remarkably calm. Sterling is up and so are gilts.

The government had to set out a clear plan for cutting the budget deficit, and did so. Labour, had it been re-elected, would have had to carry out a much more bloodthirsty spending review than it had let, and raise taxes, despite protestations to the contrary from some of its leadership candidates.

The problem is not the policy itself but the way it is being presented, as I touched on in a couple of recent talks at the Institute of Economic Affairs and Reform. The £32 billion of additional spending “cuts” over the next four years was on top of £52 billion inherited, but not yet implemented, from Labour.

None of this has yet been delivered, or negotiated. There are three stages to the public spending process - set the envelope, negotiate the cuts to stay within that envelope, then deliver the cuts.

The first is easy. The second a little more difficult. But it is only during the third that you know whether you can do it or not. The government is encouraging people to look towards the end of a process that will take several years. It is also generating its own scare stories.

The more you say things are going to be horrendous, and that spending cuts will change everybody’s lives beyond recognition, the more people will believe it. When the Treasury asks most Whitehall departments to come up with potential real cuts of 40%, not only is the departmental response likely to be less than rational but the impression is created of an irresponsible slash and burn process embarked upon with great relish by the governmment’s young Turks.

Fun though it is for newly-appointed ministers to be so macho, it is also undermining confidence. Even some Tory MPs are uneasy about it, while their Liberal Democrat confreres can only watch as their poll ratings collapse.
Are not ministers just being straight with voters, telling it like it is? What would the alternative have been?

What I would do, and it is not too late to start, is firstly remind voters, and government departments, that we have just been through the biggest spending splurge in our history. If there is a good time to diet it is after a feast, not a fast.
Then I would point out that even the government’s savage spending envelope allows for public sector current expenditure to rise from £600 billion in 2009-10 to £711 billion in 2015-16, a cash rise of 18.5%.

Between 1994-5 and 1999-2000, current public spending in the UK went up by just 14.9%, a comparable rate of increase to tht planned now. There was no talk then of 40% cuts or Canadian-style surgery on the public finances, but it was achieved - Britain went from a budget deficit of 8% of GDP to a surplus over five years.

I am aware, of course, that £36 billion of the spending increase to 2015-16 is taken up by additional interest payments on government debt. The Office for Budget Responsibility has also pointed out that so-called “resource” limits for departments in 2015-16 will be 12% lower than if they had merely kept up with inflation. For capital spending the gap is even greater; 30%.

That, however, adds to the argument for looking for bigger savings elsewhere. The big cash increases over the next few years are social security, up £30 billion, tax credits, up £6 billion, public sector pensions, £7 billion, and even contributions to the EU, £4 billion.

There are two dangers of huffing and puffing too much about cuts. One is that consumer and business gloom becomes self-fulfilling, restricting the economy’s ability to grow its way out of debt.

The other is that the government gets a reputation for savage cuts but fails to deliver, the worst of both worlds. That was the fate of the Thatcher government in the early 1980s. Surely history won’t be allowed to repeat itself.

Ministers need to lighten up on the austerity message. Otherwise they will end up with an austere economy.