Fisher Investments Editorial Staff
Deficits, Developed Markets, Politics

No Pain, No Gain for Ye Olde Brits?

By, 10/21/2010

Story Highlights:

  • The British government announced £81 billion ($131.5 billion) in spending cuts over the next four years.
  • The government aims to reduce its £109 billion ($177 billion) structural deficit, one of the highest among developed economies.
  • Though fiscal austerity can cause near-term dislocations, in the longer term it could produce structural benefits.
  • Critics worry the government's focus is wrongly on drastically reducing the deficit to the potential detriment of the economy.
  • However, the UK is a small part of the world and is actually growing more healthily than most would have assumed months ago.

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Details of the British budget plans for the next four years were released Wednesday—and we wonder if those stiff upper lips aren't quivering. The government announced £81 billion ($131.5 billion) in spending cuts though 2015—not insignificant.

In speeches earlier this year, the newly established coalition government formed between the Conservatives and Liberal Democrats promised to reduce the £109 billion ($177 billion) UK structural deficit to 0.8% of GDP by April 2015. Not an easy challenge considering the nation's current public deficit sits at 11.5% of GDP—one of the highest among developed economies—and the government is on pace to surpass its 2010/11 borrowing target if present cash-raising trends continue. But they're giving it a go, and some main aspects of the four-year budget program announced Wednesday include:

  • Eliminating 490,000 public sector jobs (8% of total public jobs), with the intention a growing private sector would soak up the extra unemployment.
  • Reducing welfare expenses by imposing limits on some forms of long-term jobless benefits, curbing benefits fraud, simplifying the benefits system, and placing limits on welfare payments so they don't surpass median incomes of working households.
  • Raising public housing rental prices to more closely match market rates for private housing.
  • Raising the retirement age from 65 to 66 beginning in 2020, earlier than planned.
  • Restricting child benefit payments to people earning less than $70,000.
  • Reducing budgets of local government councils, Britain's diplomatic corps, and even the royal household.
  • Cutting spending on defense and police, while maintaining or increasing allocations to health, education, overseas aid, transportation, curbing tax fraud, and national security.

It's true, fiscal austerity can cause near-term dislocations. But in the longer term it could produce structural benefits, including gains in productivity and efficiency. Just looking at the laundry list of cuts, a true free-market proponent won't be heartbroken to see reductions in public employment and entitlement programs. That doesn't mean austerity is ever an easy pill to swallow politically—though cutting spending was a key promise in British PM David Cameron's campaign.

Critics worry the government's focus is wrongly on drastically reducing the deficit to the potential detriment of the economy, which is still struggling with elevated unemployment as is. Aside from spending cuts, the national sales tax (the VAT) and capital gains taxes are set to rise and a temporary tax on bank balance sheets will be made permanent. These measures are no doubt negatives for British economic growth.

However, in every country and every economic cycle, negative factors co-exist with positive—no economic environment is ever pristine. The question is whether the positives outweigh the negatives, and there are positives aplenty globally.

Further, the UK is a small part of the world and is actually growing more healthily than most would have assumed months ago. It's also important to note while the government is looking down a more austere road, British monetary policy remains very accommodative, with the Bank of England's Monetary Policy Committee recently voting to maintain low 0.5% overnight rates and £200 billion in government bond purchases. Additionally, British banks appear well-capitalized and lending seems to be turning a corner, while retail sales have surpassed expectations.

Plus, if a bit of growth diminishes the public deficit as a percentage of GDP, it could shave off political will for spending cuts scheduled down the line.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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