Analysis: Big cuts still ahead on Britain's road to clear deficit

Reuters Business News
Posted: Aug 28, 2012 8:31 AM
Analysis: Big cuts still ahead on Britain's road to clear deficit

By David Milliken

LONDON (Reuters) - Two years into an unpopular austerity program, recession and bleak public borrowing figures have heaped pressure on Britain's government to change course.

The cuts have been so painful that nearly half of voters believe finance minister George Osborne should be removed from his post. But if he stays and sticks to his plan to eliminate most of the deficit by 2017, much worse is to come.

He has made a less of a dent in the deficit than hoped, and three quarters of the pain still lies ahead with widespread cuts to spending and benefits likely to have a bigger impact on voters' wallets than the tax rises and reduced investment to date.

A return to strong growth might make cuts easier but economists do not forecast this for at least a couple of years, a problem for the government with an eye on re-election in 2015.

"It is going to be a long, hard slog," said Simon Hayes, chief UK economist at Barclays. "Reforms of welfare have only just started. It is inevitably the case that the first things you do are the easiest, and things get tougher as you go on."

Progress on cutting Britain's budget deficit has been slower than planned since the Conservative and Liberal Democrat parties formed a coalition in May 2010 with the chief aim of getting Britain out of the deepest fiscal hole of any major economy.

Osborne's original goal of eliminating most of the deficit before the 2015 election has already slipped to 2017, and two ratings agencies have put Britain's prized triple-A debt rating on a negative outlook.

Lower than expected growth over the past two years is the main reason for the budget shortfall, and the opposition Labour Party has stepped up calls for the government to slow spending cuts, which it blames for "a recession made in Downing Street".

Britain has recovered much more slowly than other countries from the financial crisis, and apart from Italy is the only one of the world's 20 biggest economies that is back in recession.

However, Britain's finance ministry strongly resists any deviation from Osborne's goal of eliminating Britain's structural current budget deficit over the next five years.

"The coalition inherited ... a huge fiscal challenge, and we have always been clear that dealing with that was going to be a slow and difficult process," junior finance minister Chloe Smith told Reuters last week, after data showed public borrowing from April to July was 11.6 billion pounds higher than a year before.


The size of Britain's challenge becomes clear with a close look at Osborne's budget statements - published in a largely monochrome format that contrasts with his Labour predecessors' glossy, full-color publications.

Britain's budget deficit in the 2011/12 fiscal year was down to 8.2 percent of GDP from its peak of 11.2 percent just before the Conservative-led coalition came to power - smaller than the United States', but still higher than anywhere in the euro zone other than Spain, Greece or Ireland.

More significant is the cyclically-adjusted current budget, the part of the deficit which will not evaporate when the economy starts growing again at its long-run average, and which strips out long-term investment projects.

This is what Osborne wants to bring into surplus by 2017, and is a hole that any future government will need to fill. In 2009/10, it amounted to 5.5 percent of GDP, and two years later it has only fallen to 4.6 percent.

To close this deficit, the Treasury estimates that 155 billion pounds of permanent savings need to be found, of which 41 billion pounds were achieved over the past two years - just over a quarter the total required.

Part of the savings - around 17 billion pounds - come from lower debt interest costs, which helps explain why the Treasury is so keen British bonds do not lose their safe-haven status.

But the rest will be a very different type of austerity to what has come before, with much more emphasis on saving money spent on existing government programs and benefits.


So far most fiscal consolidation has come through tax hikes - notably a rise in sales tax to 20 percent - cuts to central government capital spending, and lower grants to local authorities for services ranging from libraries to social care.

One example of the impact, according to a study for the Unison trade union, is that the fees for day care centers for vulnerable adults have been raised from nominal levels to as much as 50 pounds a day and some centers have shut altogether.

Much more of this is to come. While 60 percent of planned tax rises and cuts to capital spending have been achieved, around 90 percent of cuts to ongoing central government spending and benefits are yet to take place, and few departments have published detailed plans on how to achieve them.

Around one third of cuts to so-called 'non-interest annually managed expenditure' - mostly benefits - are due to come in the next fiscal year, when fresh restrictions to rent subsidies and disability and child benefits kick in.

For example, every working-age claimant of disability benefit will be reassessed by a government contractor rather than their family doctor to see if they are fit to work - which the government hopes will cut benefit payments by 20 percent.

How cuts to other areas of spending will be made is less clear. One way is through reducing the amount of money the government pays private companies for goods and services, which Barclays economist Simon Hayes says seems to be the main area where savings have been made so far.

"To some extent that seems to be to just getting better value for money. That's a positive," he said.

An example of this at local level is the case of Britain's biggest outfitter of fire trucks, John Dennis Coachbuilders, whose chairman Alan McClafferty is promoting smaller fire engines to cash-strapped fire authorities.

Rather than a 20-tonne behemoth arriving to extinguish a smoldering rubbish bin - the sort of small-scale incident that accounts for the bulk of emergency calls - a 10-tonne engine, costing about half the price, might come instead.

But McClafferty also said that salaries and pensions for firefighters, not new engines, accounted for the overwhelming bulk of a fire authority's costs.

Staff costs are a major issue for central government as well, where wage costs have risen to 88.9 billion pounds from 87.2 billion in 2009-10, despite a wage freeze that started in 2010 and widespread job cuts.

Barclays' Hayes says this unexpected increase may be down to one-off redundancy and retraining costs. But others worry total public sector job cuts could need to be higher than the 730,000 predicted by the government's budget watchdog, of which 400,000 have taken place, most in local government.

"Maybe it will prove really hard to cut non-wage costs. If you look at a school or a hospital, the heating bill isn't really in your control," said Carl Emmerson, deputy director of the Institute for Fiscal Studies think tank.

Mike Turley of consulting firm Deloitte said that the government could save almost 20 billion pounds by improving cash management and cutting fraud rates to private-sector levels.

But ultimately, a return to economic growth will be key to sweetening the bitter pill of austerity as the Conservatives and Liberal Democrats seek re-election in 2015.

Economists polled by Reuters earlier this month predict Britain's economy will contract by 0.3 percent this year, before resuming tepid growth of 1.3 percent in 2013. The Bank of England says it will be at least two years before growth is likely to return to normal.

"This would all be easier if the economy was growing more strongly," Hayes said. "The longer the economy stagnates, the more difficult it will be to go through with the plan, both in terms of the bare maths of public finances and the politics."

(Editing by Anna Willard)