Sunday, October 10, 2010
Business will feel the cuts too
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular piece is available to subscribers on www.thesundaytimes.co.uk. This is an excerpt.

It was brave for the Tories to attack last week one of the welfare state’s sacred cows, risking the wrath of its own supporters in middle England and demonstrating that the pain of the cuts will reach up the income scale.

What there was no excuse for, however, was announcing the change in such a cackhanded way. One characteristic of the Conservative team in opposition was the effort it put in to ensure external experts backed its numbers.

Perhaps it was the pressures of office, or of putting together the chancellor’s party conference speech in haste. Perhaps, to take the Machiavellian interpretation, the chancellor’s deliberate intention was to generate maximum anger in the short-term in return for long-term gains.

That is too generous. Something went badly wrong. You did not have to be a tax expert to spot the immediate double-income flaw in the crude removal of child benefit for higher rate taxpayers - two parents earning £40,000 each get it, a single earning parent on £44,000 does not.

It was predictable that the Institute for Fiscal Studies would warn that the move “seriously distorts incentives” for families with main earners. Nobody would know this better than Rupert Harrison, George Osborne’s special adviser, who used to work at the IFS.

So the episode is puzzling, and potentially worrying, though the Treasury has time, until 2013, to straighten it out. But if so much political flak has been generated over just £1 billion of cuts, the omens on the face of it are not good for the remaining £82 billion. The other big announcement, limiting benefits to no more than average household income, is easier said than done.

The chancellor was bold enough soon after his June budget to name the date for the spending review, October 20, just as the coalition was bold enough to say the next election will be on May 7 2015.

In the case of spending, it may have been a bit too bold. There is always a scramble as the date of the review approaches but the signs from Whitehall are that a lot of big decisions are going to the wire, though the Treasury denies any ministerial cold feet about the timing of the cuts. In the past, the Treasury left naming the date of the review as late as possible. This one is set in stone.

As it is, the child benefit episode prepares us for the howls of pain that lie ahead. How serious will they be? Several people have suggested to me recently that politicians and commentators have underestimated the extent to which there will be a backlash against the cuts.

Not only is anger against bankers undiminished but politicians are seen as part of that same establishment. When the cuts bite, the argument is, the backlash will be bigger than anybody expects.

I would not dismiss this. There is anger out there. The fact Britain does not do protests in the way some other European countries do should not be taken for granted. Nor should the idea that a government that is doing the right thing by the deficit will get much support for it.

Here, the role of business could be pivotal. Not only does the private sector have to generate the jobs and employment to offset public sector cutbacks, but businesses have to be prepared for their own disappointments in the spending review.

Vicky Pryce, former chief economic adviser at the Business Department, now with FTI Consulting, says most firms are in denial about the direct and indirect impact of the cuts on their business.

Business lobby groups have been united in calling for action to cut the deficit, while at the same time urging that infrastructure spending, on roads, rail, hospitals, schools and so on, be spared the axe.

That, barring a miracle, is not going to happen. The scrapping of the Building Schools for the Future programme, an even clumsier example of policy implementation than child benefit, was a harbinger.

Gross capital spending by government will drop from almost £69 billion last year to £43 billion by 2013-14, a fall of 38% in cash terms and something approaching a halving in real terms. Net of depreciation, the capital spending fall is even bigger, from £49 billion last year to £20 billion in 2013-14.

In this area, smoke and mirrors are the norm. The prime minister, in his Tory conference speech, offered a future of superfast broadband and high-speed rail. To be fair to him, independent bodies like the Construction Products Association are optimistic about prospects for rail and energy projects, even amid the big capital spending squeeze. Business will not get all it wants from the spending review.

The bigger question is whether the economy gets what it wants. Though the unions deny it, official figures show clearly that public sector workers earn more on average than their private sector counterparts. The bigger the sacrifices on pay, the more public sector jobs - which the Office for Budget Responsibility expects to drop by 600,000 - can be preserved.

The more reforms to public sector pensions are pushed through, in line with the recommendations of former Labour minister John Hutton, the more the public finances will be sustainable in the long-term.

On the face of it, the challenges do not look as great as they have been portrayed. The government’s overall spending will continue to rise in cash terms over this parliament, though it will be severely squeezed in real terms, particularly non-ringfenced departments.

The coalition’s aim, of returning public spending to the equivalent of just under 40% of gross domestic product by 2015-16 does not look hugely demanding; that is where it was in 2003-4. But the composition of spending has changed. What Gordon Brown used to call the bills of failure, debt interest and unemployment-related spending, takes a much bigger share of the cake. Capital spending, as noted, is being slashed. Public spending needs rebalancing as much as the economy does.