The 2011 Budget and its global context

Hugo Radice picks apart Osborne's budget, and predicts difficult times ahead for the UK economy.
March 2011

The massive turnout on March 26 in London provided a vital public repudiation of the ConDems’ austerity programme.  But although opinion polls show that a large majority of the public say that the cuts in public spending are unfair and too fast, more than half still think they are necessary.  As opposition heats up all over the country, with local opposition groups being set up and public meetings and protests taking place, it is vital that the left continues to argue against the cuts.  Far from being based on ‘scientific’ economics, the cuts form a determined attempt to make the poor pay for the bankers’ blunders, and to change fundamentally the relation between the citizen and the state in Britain.  And what’s more, the austerity programme may well make the chances of a general economic recovery worse rather than better.

In developing our arguments over the coming months, we need a good understanding of the likely consequences of the budget, in the context of the ConDems’ overall fiscal strategy and the global economic outlook.

The budget



In his 2011 budget, George Osborne was clearly determined to stick with ‘Plan A’, adding little to the barrage of measures already decided in the emergency budget last summer.  We are now braced for the full impact of those measures, especially from local authority job cuts, reductions in a range of benefits, and the rise in national insurance contributions.  The Institute for Fiscal Studies has once again shown that these cuts will bear most heavily on the poor;  although the top 10% will have their incomes reduced significantly by the 50% income tax rate, for the rest of us the proportional fall in income expected over the next 5 years increases as you go down the income scale.  And to this, we have to add the hidden extra costs imposed on large numbers of households by the loss of public services such as libraries, day centre provision, rural bus services, and so on.

Osborne’s only substantial change in the budget was a reduction in corporation tax.  He claimed that this would encourage businesses to invest more and take on more workers, but as Keynes pointed out long ago, changes of this kind – a few percent off tax or a small reduction in the cost of borrowing – have no effect if business confidence is low and if households are cutting back on spending.  And as the cuts work through and spending falls, confidence is very likely to fall.

He also tried to appease the growing public discontent over the cuts with new measures helping motorists, first-time housebuyers and jobseekers.  These were fully funded by new revenues from North Sea oil, tax avoiders and the banks, so the net effect on total demand is precisely zero.  But the measures were in themselves so modest that they are unlikely to lift the encircling economic gloom.  Although he may have thought he would win public support by taking more tax from the North Sea oil producers, a penny less a litre is not going to cut much ice given that the price has risen by 20-25 pence since the election.

The second issue for this budget was whether Osborne could find some way to increase the chances of economic recovery, given Labour’s persistent accusations that he had no strategy for growth.  He knows very well that even if the coalition succeeds in its efforts to ensure that the present parliament lasts a full five years, there is little chance of re-election if the recovery is not in full swing well before that deadline.  For this reason, the main emphasis in his speech was on ‘reform’ and ‘rebalancing’.  He painted a picture of an entrepreneurial economy in which manufacturing, supported by a slimmed-down and efficient public sector, becomes the new engine of growth.  For this purpose, he  put together a menu of measures on enterprise zones, apprenticeships, technical education and tax breaks for innovation.

Such measures are all too familiar from the history of economic policy over the last half century, during which manufacturing has continually declined in terms of its relative weight in economic activity.  Is there any reason why these measures will work this time round?  Part of the problem is undoubtedly that most of the proposals will take a good while to implement, and even longer for their effects to feed through into jobs and incomes.  The creation of new enterprise zones looks helpful on the face of it, especially in those regions of the UK which will be hit hardest by the decline in public sector employment.  But the enterprise zones will have to be managed by the public sector, and the main reservoirs of expertise on regeneration, the Regional Development Agencies, are even now being dismantled and their staff dispersed.  On top of this, many experts on regional development have argued that enterprise zones merely shift jobs from one part of a depressed region to another, with little net increase in employment.  Proposals for expanding apprenticeships and technical colleges, and to extend tax reliefs for innovation and business start-ups, have likewise been a staple of many past attempts to revive British industry, but will take time to have any effect.

The Chancellor’s theme of ‘reform’ seems to involve cutting the cost and complexity of both taxation and regulation.  While no-one in their right mind would oppose such a worthy aim, history suggests that this will prove extremely difficult.  The complexity of public policy reflects the complexity of modern society;  the red tape that supposedly strangles local development proposals has evolved in response to the greater importance that citizens have come to place on their environment and amenities.  The furore over the proposed high-speed railway through the Tory-voting Chilterns provides a case in point.

The global context



Overall, the success of the Chancellor’s 2011 budget depends in any case on matters outside his control, matters about which he remained very largely silent.  The economic forecasts published on 23 March by the Office for Budget Responsibility reflect the widespread view that economic prospects for the UK look weaker than they did last summer: growth in 2011 is now expected to be 1.7% rather than 2.1%, while the forecast for 2012 is marginally reduced from 2.6% to 2.5%.  This revision is based largely on concerns that higher-than-expected inflation will cut into household spending, and therefore a slower growth of output.  In turn, that will also make for a worse fiscal outturn, due to lower tax revenues and higher welfare spending.

But the OBR also points to an improving outlook for the world economy as a whole in the next two years, which raises the questions of whether this optimism is justified, and whether the UK can participate fully in the global recovery.

How do our rulers currently view the world economic context?  First, the concerns widely expressed earlier in the year over tensions between the USA and China seem to have abated;  the interests of their political and business élites are too closely intertwined for either side to risk a serious rupture.  Instead, the last three months have seen three different areas of concern for global capitalism.

First and foremost, turmoil in the Middle East has had both immediate and longer-term consequences.  The loss of Libyan supplies has dramatically affected the price of oil, not so much because of the volume – Libya is a minor global exporter – but because the specific characteristics of Libyan oil and its regional delivery patterns had knock-on effects on other parts of the global oil market.  The price rise in itself, alongside continuing global increases in food prices, has increased inflationary pressures, the UK being a case in point.  This affects the short-term prospects for global economic growth, by forcing consumers to cut their expenditure on other goods and services.  Higher inflation has also encouraged the City to increase their pressure for a rise in the Bank of England’s lending rate: the government’s Keynesian critics argue that such a rise would reduce growth prospects still more.  In the longer term, for global capitalism the emergence of stable democracies may mean that at last, economic progress in the Middle East will be commensurate with their wealth of natural resources, but the picture will remain unclear for many months, if not years.

Second, the disasters in Japan have disrupted supplies in some sectors and countries, but the overall economic impact for global business is mixed.  Many economists argue that it will be positive, because reconstruction will provide business opportunities for many sectors which will stimulate their growth.  But there are concerns about the fiscal health of the Japanese state, which has one of the highest domestic debt levels in the world, and about the rising tide of criticism aimed at the Japanese political class over the way the crises have been handled.  In addition, the global consequences of the Fukushima nuclear disaster for nuclear energy policy have already been felt on the other side of the world in the state elections on 27 March in Germany: the CDU was roundly defeated in Baden-Württemburg, and the leader of the Greens is likely to become Minister-President.

Thirdly, the management of the sovereign debt of weaker Eurozone economies continue to be a source of uncertainty for global financial markets.  The fall of the Socialist government in Portugal was the direct result of the conservative opposition’s refusal to endorse a cuts programme of Osborne proportions.  The opposition instead advocate a bail-out by the EU and IMF, presumably on the grounds that Portugal’s politicians can then blame the cuts on external forces.  But no-one questions the role of bond market speculators.  They have developed the habit, ever since the first doubts surfaced about Greece’s financial health in late 2009, of picking on targets for their favourite practice of ‘short-selling’.

How does this work?  First, they place bets that the market price of a country’s bonds will fall; then they spread rumours of impending default, hopefully leading the ratings agencies to downgrade the bonds; then the price falls and they snap up the bonds on the cheap; and finally, an external intervention restores market confidence, the bond prices rise again, and they walk off with the profits.

Despite these three potential hits to global business prospects, there is little sign that bodies such as the International Monetary Fund and the Organisation for Economic Cooperation and Development are revising downwards their optimistic forecasts of global growth.  They expect the BRIC (Brazil, Russia, India and China) and other ‘emerging’ economies to continue their very rapid growth in the next 4-5 years, and the ConDems clearly hope that some of this growth will take the form of increased demand for British goods and services: hence, for example, the current high-level trade promotion trip to Mexico led by Nick Clegg.

But even if the global growth forecasts turn out to be correct, there must be concern about how UK-based businesses will fare in competing in these markets.  In 2010, the economies which import from the UK increased their total imports by 10.7%, but UK exports only grew by 5.8%, so our share of those markets declined.  Indeed, the OBR in its Economic and Fiscal Outlook says that

“relatively little of the recent strength in nominal spending has translated into domestic household wages or corporate profits. The majority of last year’s increase in spending was accounted for by higher spending on imports and higher taxes, generating income flows for overseas companies and the government rather than UK households or firms.” (p.51)

In other words, growth in exports did not feed into growth in domestic output and incomes, because of tax rises and higher imports!  Nevertheless, the OBR still forecasts that for the next three years, we will increase our share of overseas markets.  Likewise, business investment is expected to grow by an average of nearly 9% per year from 2011 to 2015, more than offsetting a steady decline in government investment.

If UK exports and business investment both meet these targets, which are very ambitious by historical standards, then George Osborne’s Plan A will certainly be judged a success - in terms of conventional economic measures of performance, and ignoring the devastating effects of the cuts on households and communities.  Otherwise, he will be hard put to restore the coalition’s popularity in time for the next election.

29 March 2011

h.k.radice@leeds.ac.uk

http://www.polis.leeds.ac.uk/about/staff/radice/


 

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