Wednesday, January 20, 2010

Britain's New Realtiy Show: Austerity

In 2007 Britain’s national debt was 44% of GDP and the cost of insuring the debt incurred by the British Government was app. £5,000 for each £10 million of securities they issued. In 2014 Government debt in the UK will be 75% of GDP and the current cost of insuring £10 million of the securities needed to underwrite the debt is £72,000. The Government is in trouble and relies on the Bank of England to print money (euphemistically called “fiscal easing”) so as to manage its debts. It is threatened with a lowering of its debt rating by the debt rating agencies, who are concerned that, sometime soon, Britain may default on its debt.

But the challenge of reducing debt while encouraging an economic recovery is becoming a focus for the election, likely to take place in early May of this year. Britain has over 2 million unemployed and some one third of adults receive one form or other of welfare payments. There are two million children in Britain growing up in homes where no-one works. 7.5% of GDP is now spent on welfare provision.

What options does an incoming Government have in terms of reducing its debt load while stimulating the economy. Not many.

Option 1: The first is to cut programs in this vast welfare state while at the same time raising taxes. This is the option favoured by the Conservative Party. Its Shadow Chancellor, George Osborne, has indicated that cuts will begin in its first week in office, should the party win the election. However, for reasons of political expediency, it has already protected some key budgets – especially health. Labour has also indicated that they will seek to reduce public spending in a “measured and planned” way – seeking to contrast their way of cutting with that of the Conservative Party. Their strategy – freeze public spending at 2011 levels for five years. This does not take full account of the fact that there are structural problems with the UK government budget – there is a permanent gap between spending and income of some £90 billion.

Option 2: The second option is to encourage inflation, which would wipe out the value of the debt, making it easier to pay off. Such a strategy has consequences. It doesn't just wipe out debts, it wipes out people's hard-earned savings and increases the number living in poverty, expanding welfare and creating additional government spending. It also leads to sizeable wage claims and labour unrest.

Option 3: Is to seek assistance from the International Monetary Fund (IMF). Britain did this in 1976 when Dennis Healey was Chancellor and Harold Wilson was Prime Minister. Healey asked the IMF for a £2.3bn bail out, saying unemployment and inflation were at exceptional levels – with unemployment notably lower than they are now. The IMF does not just loan funds – it does so with conditions, usually associated with severe public spending cuts and wage constraints in the public sector.

Option 4: Britain could just default on its debt. Not pay it. Other countries have done that in the past, but rarely have these been G8 countries. The immediate impact would to make borrowing by British based organizations, especially public ones, both more difficult to obtain, more expensive in terms of interest rates and insurance against non-payment. While this openly mentioned in policy discussions, all parties mention it and dismiss it in the same sentence. Britain’s credit rating, already under constant “watch” status, would be lowered.

Whatever actions are taken by whichever government wins power in May, it is not likely that Britain’s debt will be under control and back below a “safe” level (40% of GDP) until 2032, according to the Institute of Fiscal Studies. This assumes significant tax rises, cost cutting and inflation are all part of the strategy. Any independent assessment dismisses the current governments forecasts as too fanciful. Some analysts suggest that it may take until 2040 to bring spending back in control.

Austerity will be the catchphrase that Briton’s will hear more and more of over the next twenty five years. Yet when Gordon Brown came to power, thing looked very different.

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