Business Talk with Robert Lloyd Griffiths
By Effective Communication
WHAT an incredible political period we’re experiencing! With the UK being overseen by a Labour Government until early last month, it shows that if a week in politics is a long time then seven weeks is an eternity.
Now, in the blink of an eye, we have seen new alliances formed, the Office of Budget Responsibility created, that same OBR issue an intriguing economic re-forecast and an announcement that the Financial Services Authority is to be abolished.
As we continue to come to terms with the thrilling novelty of an unlikely coalition government we’re today on the threshold of one of its biggest early challenges – tomorrow’s emergency Budget.
In my opinion, we’re at a fork in the road for fiscal policy. With the right decisions prospects for recovery in the short-term and economic growth in the long-term could be enhanced. But there’s also a risk that the wrong decisions could hasten a double-dip recession and damage long-term competitiveness.
The two most important measures in the Budget should be:
· Deficit reduction which goes deeper and faster than financial markets expect. The IoD has hardened its position on deficit reduction and is now calling for a cash squeeze (as compared with a real freeze in spending) over the 2011-12 to 2015-16 period. Closing the structural deficit alone is not enough. The overall deficit in public sector net borrowing needs to be almost eliminated as well – over the course of the Parliament.
· Deficit reduction being overwhelmingly based on lower public spending. The IoD has consistently argued for a 4:1 ratio of spending reduction to tax increases. Ideally all the adjustment should fall on spending but if taxes are to rise the focus should be on indirect taxation. Higher direct taxation in particular would risk a double dip recession and also undermine the long-term incentive to work, save and invest.
The Chancellor needs to set out a big deficit reduction package, but the nature of the package is just as vital as its size. Raising taxes significantly would ensure that we fail to get a strong private sector recovery, killing off the growth we are trying to create. Cutting public spending is the necessary course of action, and should be accompanied by measures to ensure that the resources lost in the public sector are able to be picked up by a strongly recovering private sector.
I don’t think rapid deficit reduction based on lower spending will undermine economic recovery. At times of fiscal crisis the normal rules are switched off. There is very strong evidence from economic history over recent decades, that we can have an expansionary fiscal consolidation. The immediate direct impact of lower public spending is to lower GDP but indirect effects quickly kick-in to raise private sector spending. The silver lining here is that tight fiscal policy might help maintain near zero interest rates for years not months.
The tough Lamont-Clarke fiscal tightening, with 600,000 public sector job losses in the mid 1990s, did not prevent sustained economic recovery. Also, the period of fastest economic growth under Labour was during its first two years in office, when public spending fell sharply as a proportion of GDP.
The IoD Budget representations also include:
· A warning that the shape of economic recovery is likely to be closer to an L than a V. The IoD forecasts 0.9% GDP growth in 2010 with just 1.9% in 2011.
· An observation that if the cyclical upturn is much more robust the inflationary risk will force the MPC to reverse quantitative easing.
I like the fact that there are also calls to reduce public spending without significantly harming capital projects vital to future growth, to ensure that the effect of the National Insurance increase is fully reversed, to reduce the main corporation tax rate and to accompany any increase in capital gains tax rates with generous reliefs.
George Osborne … over to you!
Robert Lloyd Griffiths is director of the IoD in Wales. The IoD’s Budget representations can be found here: http://press.iod.com/fiscal_paper.pdf.
Tags: Chancellor, Emergency Budget, Financial Services Authority, FSA, George Osborne, Institute of Directors, IOD, Labour Government, OBR, Office of Budget Responsibility, Robert Lloyd Griffiths, Wales
