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12 August 2015

Austerity




Austerity - a Recipe for Disaster? 

Austerity is a policy decision made by deficit running governments to reduce public sector spending. Combined with increases in taxation, it is by all academic analysis supposed to help to balance the national current account and eventually push a country into surplus territory so that the actual debt of a nation can be repaid. The UK is in exactly this position and in principle the policies are sound; however, based on the current circumstances of the UK economy there may just be a catch and unintended consequences that will render the policy unworkable.

Ideology

The recent UK election result was the green light for an ideological Conservative policy response to the current economic situation which the previous five year tenure was unable to achieve. The softly, softly coalition response to deficit spending and increasing debt loads was generally administered against the wishes of the harder line Conservatives; so with outright victory in the election the door opened to the ideological shrinking of the state in terms of government and welfare spending in order to balance the budget in double quick time. This all sounds promising in principle, but are we being blindly led into an economic trap?

Cuts

If we consider the implications of welfare cuts specifically, they include payments to the sick and disabled, the unemployed, single parents, the retired/older persons and veterans but more practically cuts to the tax credit system. Unfortunately, tax credits have become a lifeline for many families across the UK, helping to balance their budgets. Many might say that the onus of responsibility is on the individual to make sure that they live within their means and I would wholeheartedly agree with that response; however, by implementing major cuts whilst continuing to live with the consequences of the 2008 financial crisis (which incidentally have never gone away but been postponed to a future day of reckoning) and subsequent “depression”, we are going to reduce a major part of the population to significant hardship with the very real possibility of prolonged economic contraction. - money supply contraction, or the dreaded deflation that we have been so frequently warned of and a fall in the velocity of money as belt tightening becomes inevitable. The debt base of the country in real terms would then increase as the supply of liquidity dries up. The consequences of cuts would almost certainly tip the UK economy into another major downturn.

The Squeezed Middle

The typical UK family has been squeezed financially since 2008. General levels of private debt are back on the increase as media proclamations of strong recovery boost confidence, but much of that new debt is probably helping to finance living expenses. Lower real pay levels at the heart of the squeeze have been due to a stagnation in wages created principally out of uncertainty after the crisis but our open door immigration policy - forced upon us by Brussels - hasn’t helped. All time low interest rates manipulated by the central bank have helped to stave off a collapse of family budgets up to now alongside tax credits which in many cases have been the difference of whether the family sinks or swims. Thus, as the implementation of Conservative ideology starts to bite what can we expect from the UK economy?

The Trap is Set

It is the consumer that drives the economy to the tune of 64% of GDP. A contraction in money supply brought about by cuts will emerge in the spending capability of the average person. This in turn will lead to a fall in business profitability followed by pay and workforce cuts. This, in its turn, will affect the government tax take negatively. The UK debt to GDP ratio will start to increase again putting pressure back onto UK interest rates. As confidence softens in the international markets a spike in interest rates would not only dent an unstable recovery but would undermine a massively over leveraged housing market, the Achilles heel of the domestic financial system. This would directly affect families as mortgage repayments would increase sending an already fragile public into a spiral of unsustainable living expenses. The vicious cycle would undoubtedly pressurise the government to back track on their policies if by then it was not too late.

Eyes Wide Shut

Policy decisions made by governments based on ideological grounds are all well and good in principle but they do not necessarily take into account all factors and subsequently unintended consequences result. Politicians mainly act in good faith and with the best of intensions but do not always have the correct prescription for the ailment. Let us hope that the current government delivers its plans in a considered way as we are only really a couple of steps away from turning Greek!      

             

This article was written by Richard Horswill. All views, opinions and conclusions are strictly his own

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