FORUM: If you were the Chancellor, what would you do?

Published: 5 August, 2010
BY JOHN MILLS

• WHAT would you do if you were the Chancellor of the Exchequer?

Clearly something has to be done about the financial deficit, which ran at 11 per cent of national income last year.

It is not sustainable for the Government to borrow one in every four pounds it spends, as it did in 2009/10, rather than raising most of the money to pay for its outgoings from taxation.

On the other hand, the faster and harder the Government cuts its expenditure, and the pressure on the economy consequently falls, the more likely it is that we will fall back again into recession.

If this happens, the heavy costs of having hundreds of thousands of extra people out of work will have to be met somehow, while at the same time economic activity and the tax take will fall.

The danger then is that the deficit finishes up as big as it was before while the economy tanks.

George Osborne, the Chancellor, is gambling that this will not happen.

He is assuming that those who are set to lose their jobs as a result of cuts to public expenditure – perhaps 600,000 people in total – will find jobs in the private sector at more or less the same time as publicly-funded employment falls.

If he is right, then the policy he is pursuing may work.

As government expenditure falls, the tax take will rise with increased private sector activity, and the government deficit will narrow to manageable proportions.

The Chancellor’s strategy is certainly one with high risks attached to it. What is going to make all the new private sector jobs materialise?

Consumers are spending more cautiously as they start to pay off their debts.

Companies are saving money and not investing much, not least because they cannot rely on banks to perform their traditional lending role.

Our export prospects do not look great as the euro crisis undermines flagging confidence in the eurozone, which takes about half our exports.

If the Chancellor’s strategy does not work, the danger is that we finish up in the worst of all worlds.

As a result of the current cuts, we have worse public services, more people out of work, lower living standards – and still a huge deficit.

What, however, is the alternative? Should the government just go on spending money, leaving the deficit as high as it was last year? This approach is also fraught with problems.

Financing the deficit depends on there being people and institutions willing to lend to the government on the scale required to fill the huge gap between its expenditure and revenues.

If so, what interest charges will they want?

Will they be there at all?

If not, the UK Government can always just print money to bridge the financing gap, but this way lies inflation.

This is why the Government believes that it has to show it is trying to get the deficit under control.

Is there any kind of radical change in policy which might provide a solution to the dilemma which the country clearly faces? Possibly.

There are good reasons for believing that the root problem in Britain is that for decades we have got our priorities wrong.

We have favoured finance over industry and services over manufacturing.

As most international trade is in goods and not services, we have therefore allowed our economy to become unbalanced and uncompetitive.

Because we cannot pay our way in the world, leaving our domestic economy short of purchasing power, excess government spending over revenues has filled the gap.

To put this right, we need to shift much more of our economy into manufacturing again – and to get this done, we need a much lower exchange rate, to make our exports far more competitive than they are at present.

We need banks willing to lend to industry.

We need a big shift in vocational training towards subjects such as engineering. We need government policy and  infrastructure that is seriously geared to support production.

Will any of this happen? It is very doubtful that it will, at least on anything like the scale required.

If we are unwilling to trade our way out of our current problems, however, we are all too likely to spend the coming years teetering between unsuccessful efforts to get the deficit down and mounting unemployment and stagnant living standards.

The Tories are in favour or reducing public expenditure on principle.

Lib Dems are much more ambivalent.

Where all this will leave us in a year or two’s time is indeed hard to discern.

• John Mills is Chairman of JML Direct