Britain should tackle its £175bn budget deficit in “a single stroke” with a comprehensive reform package concentrated on cutting spending, not raising taxes, according to a Treasury analysis of successful attempts at slashing debt.
The study of advanced economies that have overcome fiscal crises identifies the areas to cut as public sector employment, using both wage restraint and job losses, and entitlements and benefit payments.
Ministers were warned that evidence from countries such as Canada, Sweden, Finland and Spain suggests driving through tough measures is only possible if the public are convinced there is a crisis requiring drastic action.
Yet in recent weeks both Labour and the Conservatives have begun toning down the rhetoric on austerity, giving voters a more upbeat “go for growth” message ahead of the general election.
The unpublished Treasury paper draws on studies by the International Monetary Fund and the Organisation for Economic d and Development of more than 70 “fiscal consolidations” across 20 countries since 1974. Only 14 or so are counted as “successful” in producing a rapid and sustained improvement in government finances.
Its findings set the background to a political debate between Gordon Brown and Alistair Darling, the chancellor, over how high to put up taxes on the rich in next week’s pre-Budget report.
The paper marshals evidence to conclude that, when fiscal problems are tackled, 80 per cent of the gap is closed by expenditure cuts, with only 20 per cent or less being met by tax rises.
This mix happens to be precisely the route to recovery Mr Darling set out in his Budget this year – ahead of the Treasury’s analysis of experience from other countries. Next week’s pre-Budget report will show whether the chancellor is sticking to that prescription.
A person who has seen the report said it concluded that “ambitious and comprehensive reform packages” introduced in a “single stroke” produced better results than timid ones based on tax rises. This makes the effort more credible and demonstrates that the sacrifices are shared.
Even so, the chancellor is unlikely to follow this advice next week, when he is not expected to spell out in detail where public spending cuts will fall.
Mr Darling’s team have been as struck by an OECD finding that “intense efforts” are difficult to maintain because of “adjustment fatigue” and the fact that easy measures “tend to be done first”.
The Treasury analysis is less definitive over how far big spending cuts damage services.
Finland, Sweden and Iceland saw their overall public sector performance fall as the books were balanced. By contrast, public service performance in Canada, the Netherlands, New Zealand and Spain improved under the pressure to reform.
There is also evidence that ambitious reform can be carried out with little, if any, cost to social indicators, the paper says. Most countries where such reform was undertaken experienced stronger economic growth not just after the consolidation phase, but during it.
However, the study has nothing to say about when a big fiscal tightening should take place – the point of dispute between shadow chancellor George Osborne and Mr Darling.
Problem: Finland was hit by a severe slump from 1990 to 1993 after the bursting of its economic bubble. The budget deficit reached 7 per cent of GDP – against the 12.5 per cent the UK is expected to see next year.
Answer: Between 1993 and 2000, Finland cut primary expenditure by 14 per cent of national income [GDP]. Government employment fell, with strong wage restraint, cuts in subsidies to local government and reductions in spending on health, social care, education and public pensions. Expenditure on research and development, however, was protected.
Results: Employment in health and social services fell by 8 per cent. Productivity of health centres improved, but some groups such as the elderly and mentally ill suffered.
Municipalities raised taxes, offsetting some of central government action. Economic recovery began in 1994, though it was helped by currency depreciation. The budget deficit of 7 per cent became a 7 per cent surplus by 2000.
Problem: A banking crisis was combined with the fallout from an overheated economy in the early 1990s. The budget deficit reached 12.9 per cent of gross domestic product in 1993, and public debt climbed to almost 80 per cent – the same levels as forecast for the UK.
Answer: The government persuaded the electorate that dramatic action was needed. Public expenditure was cut by almost 16 per cent over seven years.
Permanent reductions were made in unemployment, sickness and parental benefits. Big reductions were made in public sector employment.
Results: The budget was balanced by 1997 and by 2006 public debt almost halved to just over 40 per cent of GDP.
Cuts in health spending sparked anger and increasing waiting times for treatment. But other cuts produced better collaboration between public sector agencies.
Problem: A big slowdown hit the economy after 1990. The budget deficit was running at 9 per cent of gross domestic product by 1992 and debt rose to well above 100 per cent of GDP.
Answer: After previous failed attempts to control or reduce expenditure, government went to huge lengths to explain the problem to the public. Fierce expenditure cuts for departments ranged from 5 to 60 per cent with central departmental budgets reduced by 20 per cent over four years from 1994. Public service employment fell by 23 per cent, although a chunk of that came from privatisations of the type the UK has already undertaken.
Results: The budget was balanced by 1997 and spending was down by 11 per cent of GDP between 1992 and 1999.
Departments improved integration of services. Growth and overall employment picked up early on in the process, with no significant strikes. The government was re-elected, and Canada is often cited as the best example of a successful fiscal adjustment.
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