The UK and the Budget: Shaw Capital Management Korea

In the UK it is obvious that there is no possibility of continuing

with budget deficits of some 13% of GDP, the present prospect if

no action is taken.

Unfortunately however the recent UK Budget produced no credible

plan for dealing with this problem. It swept it into the lap of the

new government after the May election, whatever that government

is.

The UK and the Budget: Shaw Capital Management Korea. The UK cannot delude themselves that rapid resumed growth will

lead to a rapid return of the previous revenue streams. UK growth

in most forecasts, ours included, is projected as slow.

In our view there is a good reason: the continuing shortage of oil

and raw materials worldwide prevents rapid growth for the world

as a whole and since emerging market economies are continuing

to grow rapidly that restricts the growth possibilities in countries

like the UK and other developed countries.

We are already seeing inflation spread into China and other

emerging countries, forcing a tightening of policy.

It seems likely that this tightening will be enough to restrain world

growth to rates that will not push commodity prices much higher.

So even the fast-growing world economies are being forced to limit

their growth ambitions; as for the UK they are achieving ‘recovery’,

but hardly enthusiastic growth.

All this will only change when innovation in raw material use has

freed up net world supplies.

Fortunately the flexibility of the UK labour market has restricted

the jobs fallout. Unemployment has peaked below 8% (just over 5%

on the benefit-claimant measure) as people have opted for wage

freezes or cuts and shorter hours … so there is underemployment

but not the disaster of double-digit unemployment rates.

But this environment is one in which tax revenues will not recover

much and in which the demands for public spending will continue.

Time will tell how big the ‘structural deficit’ … that will emerge

once the recovery is complete … may be.

But policy decisions cannot wait until this is better known. So in

this Budget the need was to produce a five-year public sector

adjustment plan.

Two things should guide this plan: keeping the taxes down and

competitive, so that growth and innovation resume, and restoring

efficiency in public spending.

The UK and the Budget: Shaw Capital Management Korea. Spending cuts

To begin with the last, the current government unleashed a massive

surge in public spending from 2000, raising it by 8% of GDP before

the crisis raised it by more again.

Everyone knew that without reform and gradual increases, such

money would be wasted; there is no practical way to spend such

vast sums without raising wages and wasting money on speculative

projects.

Productivity in the public sector duly slumped and public sector

remuneration including pensions has surged past the private sector

where market forces suggest pay should be higher to reflect greater

insecurity.

The UK and the Budget: Shaw Capital Management Korea. To reduce public spending back to where it started in 2000 as a

share of GDP (at around 36%) would require it to grow in real terms

by about 16% less than real GDP over the next five years.

Since total GDP growth over that period is likely to be about 10%,

that means that spending must be cut by about 1% a year in real

terms.

This is a feasible target. The UK Treasury under Gordon Brown

became a brute instrument of spending increase, oddly somewhat

against the protests of some departments worrying about wasteful

effects. The UK Treasury was never traditionally like this … very

much the opposite, a place from which wringing money was like

getting blood from stones.

It should be returned to its traditional function of restraint; Treasury

control, old-style, is the best instrument for forcing departments

to find the economies they privately know they can make.