The Government isn't tackling the fundamental obstacles to growth, prosperity and employment

September 21, 2011 12:15 PM

A day after the Financial Times (FT) published its startling findings showing that the structural, permanent part of the deficit could be £12 billion higher than previously thought, markets have been shaken by the downgrade of Italy's government debt by credit ratings agency Standard & Poor's from 'AA-' to 'A'. The agency has highlighted the deteriorating economic outlook and political difficulties which "limit the government's ability to respond decisively".

The downgrade has heightened fears that the Eurozone debt crisis which has engulfed Greece and Ireland is spreading. The problem is simple: governments in the West have spent too much money, more than they can raise in taxes, and those lending it to them are steadily losing confidence that their loans will be repaid. The higher cost of borrowing and the knock-on effects on prosperity and public finances due to confidence ebbing away from Eurozone governments shows what could all too easily happen in Britain. The FT's analysis shows that, far from being savage, the Coalition's austerity measures are too timid and may soon lead to market turbulence if it becomes clear that the permanent part of the deficit is larger than was previously thought.

The reason for the reassessment of how much of the deficit is cyclical (moves up and down, mirroring the wider economic climate) and how much is structural (the part that is permanent and won't be wiped out as the economic cycle returns to growth) is that the estimate of how much spare capacity there is in the economy is uncertain. A key economic factor is unemployment. There will always be some workers who quit their jobs out of personal choice while others are fired or made redundant as some companies fail and industries contract. This means, at any one point in time, there will be some unemployment as they look for new jobs, even in a booming economy. But there are various factors which mean that this underlying rate of unemployment, rather than the proportion that is caused by the whole economy being in recession, might be higher or lower, often due to government policies.

The last Government did a lot to increase the underlying rate of unemployment but the Coalition simply isn’t making the politically tough decisions that would improve matters. In fact, despite the rhetoric of a 'growth agenda' and a 'Britain open for business', it’s actually making things even worse in two important ways.

Firstly, by implementing the agency workers directive such workers will have to be treated as permanent staff. Good news for agency workers who already have contracts, but it’ll mean companies will have to think again before hiring when they want to use an agency worker. Many of those firms will hire anyway, but for some of them it might just tip the balance against making that decision to hire. And that means higher unemployment.



Secondly, the Government's decision to close the deficit by raising taxes instead of cutting expenditure has means the ‘tax wedge’ between the economic benefit individuals create by working and the economic benefit they receive as a result will continue to grow. As with the previous example, most people will be unaffected by this but there will always be some people whose decisions were not so clear cut in the first place. For those people, higher taxes will mean jobs and projects on the borderline of financial sense will no longer be worth doing. They will wait and hope something better will come along. Again, that means higher unemployment. After all, people are still unemployed if there was a job opportunity that wasn’t worth taking, even if that job would have been worth taking if taxes were lower than they are.

Decisions like these mean there may be less usable spare capacity in the economy that was thought, which means less room for catch-up growth and a lower trend rate of growth overall. Unless the Government tackles the economic fundamentals that are blocking the economy from fully recovering, and that means deregulation, cutting spending and cutting taxes, the economy will remain weak and stunted for a lot longer than the Chancellor would hope.A day after the Financial Times (FT) published its startling findings showing that the structural, permanent part of the deficit could be £12 billion higher than previously thought, markets have been shaken by the downgrade of Italy's government debt by credit ratings agency Standard & Poor's from 'AA-' to 'A'. The agency has highlighted the deteriorating economic outlook and political difficulties which "limit the government's ability to respond decisively".

The downgrade has heightened fears that the Eurozone debt crisis which has engulfed Greece and Ireland is spreading. The problem is simple: governments in the West have spent too much money, more than they can raise in taxes, and those lending it to them are steadily losing confidence that their loans will be repaid. The higher cost of borrowing and the knock-on effects on prosperity and public finances due to confidence ebbing away from Eurozone governments shows what could all too easily happen in Britain. The FT's analysis shows that, far from being savage, the Coalition's austerity measures are too timid and may soon lead to market turbulence if it becomes clear that the permanent part of the deficit is larger than was previously thought.

The reason for the reassessment of how much of the deficit is cyclical (moves up and down, mirroring the wider economic climate) and how much is structural (the part that is permanent and won't be wiped out as the economic cycle returns to growth) is that the estimate of how much spare capacity there is in the economy is uncertain. A key economic factor is unemployment. There will always be some workers who quit their jobs out of personal choice while others are fired or made redundant as some companies fail and industries contract. This means, at any one point in time, there will be some unemployment as they look for new jobs, even in a booming economy. But there are various factors which mean that this underlying rate of unemployment, rather than the proportion that is caused by the whole economy being in recession, might be higher or lower, often due to government policies.

The last Government did a lot to increase the underlying rate of unemployment but the Coalition simply isn’t making the politically tough decisions that would improve matters. In fact, despite the rhetoric of a 'growth agenda' and a 'Britain open for business', it’s actually making things even worse in two important ways.

Firstly, by implementing the agency workers directive such workers will have to be treated as permanent staff. Good news for agency workers who already have contracts, but it’ll mean companies will have to think again before hiring when they want to use an agency worker. Many of those firms will hire anyway, but for some of them it might just tip the balance against making that decision to hire. And that means higher unemployment.



Secondly, the Government's decision to close the deficit by raising taxes instead of cutting expenditure has means the ‘tax wedge’ between the economic benefit individuals create by working and the economic benefit they receive as a result will continue to grow. As with the previous example, most people will be unaffected by this but there will always be some people whose decisions were not so clear cut in the first place. For those people, higher taxes will mean jobs and projects on the borderline of financial sense will no longer be worth doing. They will wait and hope something better will come along. Again, that means higher unemployment. After all, people are still unemployed if there was a job opportunity that wasn’t worth taking, even if that job would have been worth taking if taxes were lower than they are.

Decisions like these mean there may be less usable spare capacity in the economy that was thought, which means less room for catch-up growth and a lower trend rate of growth overall. Unless the Government tackles the economic fundamentals that are blocking the economy from fully recovering, and that means deregulation, cutting spending and cutting taxes, the economy will remain weak and stunted for a lot longer than the Chancellor would hope.

Latest Blogs: