Coalition Challenges

Stories are beginning to emerge of profligate spending decisions made in the dying days of the British Labour Government. A committee of inquiry, a sub committee of cabinet, will look at spending decisions made in the final twelve months of the Labour party regime and examine their rationale. It is part of the new Lib-Con Government’s systematic attempt to reduce spending. It is the kind of thing one expects to hear from any new Government. They will also start halting decisions in progress – issuing identity cards for UK citizens, building a third runway at Heathrow, spending significant amounts of unproven technology.

So far so good. The new coalition has survived its first week with only one major rebellion. It relates to the decision, made by Cameron and embodied in the Lib-Con pact, for a fixed term parliament. A significant number of MP’s are concerned that a weak Government could survive repeated votes of no-confidence until such time as the Commons could muster a 55% majority for dissolution. The tradition has been that a vote of non-confidence on a finance related bill or a bill said by Government to be a critical bill for its agenda would lead to an election. Cameron is likely to ensure that the legislation for a fixed term enables this tradition to continue.

But the coalition has just found out where the washrooms are and are discovering for the first time what their colleagues are really thinking – the real work has yet to begin.

Three big issues confront the new Government. The first is the issue of deficits and debt. The British government is spending much more than it brings in tax and other revenues. The deficit sits at £163 billion and is likely to rise, once the final figures are in at the end of the year, to £178 billion – 12.4% of GDP. The target is to have no more than 3% of government spending funded by borrowing. Total UK government debt in the UK is 68.6% of GDP – higher than the debts of Ireland and Spain, but much lower than those of Greece (113%) and Italy (115%). Britain’s inflation rate, targeted to be no more than 2% in any year, is currently running at an annual rate of 3.4% - Britain is in serious economic peril.

To achieve the EU target of no more than 3% of GDP deficits, massive cuts in social and other programs are needed – in the order of £20 billion a year of new cuts for each of the next ten years. Targets include major capital projects (especially health care and defence), social benefits, pension allowances and public sector pay. Public sector pay is running ahead of private sector pay in a significant way – the average hourly wage paid to public sector workers is 7% higher than that in the private sector and bonuses are paid against criteria which are so soft that almost all eligible for performance bonuses get them. Pay cuts, pay freezes and pay restraints of other kinds are clearly on the cards.

The Government has ruled out, at least for now, significant tax rises. Most commentators agree, however, that a rise in sales tax (known in Canada as GST and in the UK as VAT) from its current 17% to 20% or higher (some suggest as high as 25%) is certain at some point in the near future. Other tax changes are also likely, including taxes on inheritance. The banks are also likely to be taxed on profits.

The second challenge facing the Government is a simple one. Britain does not have a sufficiently robust power supply to fuel its future. With both nuclear and coal fire power stations being decommissioned due to age, it is possible that Britain will face rolling energy black outs within the next ten to fifteen years unless significant new capacity is added. The Labour Government invested heavily in wind power and hydro power as a response to this challenge and avoided the tough decisions it needed to make on nuclear. It will fall to this coalition government to make the commitment to nuclear – the only way in which Britain’s real energy demands can be met. The coalition has made clear it will not directly subsidize the nuclear sector. It will, however, do so indirectly. The Government indicated last week that it intends to set a “floor” price for CO2 certificates needed for carbon trading – the cost of which is borne by consumers. The suggested floor price is £35 – some £23 higher than the lowest price carbon trades have reached in the last twelve months. Since nuclear developers do not have to buy carbon credits – nuclear is CO2 free – it will create a cost advantage for nuclear which should encourage and enable investors. One challenge – the new Energy and Climate Change Minister is a long time opponent of nuclear power.

The third challenge is to change the statist culture of Britain. Since Labour came to power in 1997, the role of the private sector in the British economy has declined as the role of the public sector has expanded. Over 50% of the UK’s GDP is derived from public sector activity, up from 39% in 2001 and 29% when Labour took office. Parts of the UK have become so dependent on public spending that it can crowd out private enterprise in these regions and countries. It is partly a chicken and egg situation - public spending in these regions is high because they are doing less well economically, but on the other hand a high public spending share can make a revival of the private sector difficult to achieve. And the latest data suggests that this problem is getting worse. What this has done is create a culture of dependency and a centralist, statist and bureaucratic nation. A key challenge for the coalition government is to rekindle entrepreneurship, stimulate local accountability and reduce the power of the state. It’s a tough challenge.

These three challenges alone, never mind challenges over foreign policy – Britain’s place in Europe, the military role in a modern world and defence spending – and political reform, will test the coalition to the full.

The coalition is full of young people, mainly male, with no experience of government. Some old hands – Ken Clark (Conservative – Justice Secretary), William Hague (Conservative – Foreign Secretary) and Vince Cable (Liberal – Business Secretary) – will be called upon to provide sage counsel when things get tough. A lot will depend on the relationship between David Cameron and Nick Clegg and their ability to see past the interests of party and look at the interests of the country. Right now they appear convinced that they can work their way through the challenges ahead. We will see.

This is all new to most of the electorate of Britain, many of whom have no real recollection of earlier coalition or supply and support arrangements of the past. There is a strong level of naiveté about what the Government is facing and even less of an understanding of just how tough the next decade in Britain will be. The word “austerity” is starting to be used, but this hardly conveys the level of severity associated with what this Government will have to do. The coalition will need to declare war on debts and deficits.

It is far too soon to tell if this coalition will last for five years, but it will certainly last until next year. The Throne Speech on 25th May and the first coalition budget in June will pass comfortably, but it’s the spending review and subsequent budget that will challenge the temperaments of all concerned. Tensions will be continuous, but the deep cuts and energy policy will likely be the source of fractious policy issues between the coalition partners. An election in 2011 is still a high probability.