Economists Don't Think Government Can Deliver Big Enough Spending Cuts To Calm Markets
Chancellor Kwasi Kwarteng will set out his medium term plans to bring down government borrowing in a statement on November 23 (Alamy)
Economists have warned there is a "credibility gap" between government and markets on the scale of "efficiency savings" ministers will be able to deliver to pay for tax cuts announced in Kwasi Kwarteng's "mini-Budget".
According to the Institute for Fiscal Studies (IFS), even if the Chancellor Kwasi Kwarteng sets out a plan in his fiscal statement in late November to reduce debt in the medium term through slashing departmental spending, it is unlikely to quell the economic turmoil sparked a week ago.
Government departments are already facing a squeeze on their finances as their budgets until 2025 were set out in a comprehensive spending review last autumn, which predicted inflation would peak at 4 per cent.
But since then Russia has invaded Ukraine, and the ensuing global energy crisis has pushed inflation above 10 per cent, which economists say will wipe out any increases that might have been available.
During the Tory leadership contest Liz Truss promised a new spending review to revisit departmental spending, but since appears to have dropped the plan. Instead the Chief Secretary to the Treasury Chris Philp is believed to be writing to government departments “about finding spending efficiencies”, according to Sky News.
A Treasury source confirmed there will be no further expansion of the “spending envelope” before 2025, and hinted cuts could come to departmental budgets after that.
They told PoliticsHome the Medium Term Fiscal Plan due next month “will set how we get to the path for debt falling and by when”.
Confirming that the “discipline on spending” will mean the government keeping to the plans for current spending review period, the source added that beyond that period, it will depend on economic forecasts, which will depend on the “effectiveness of supply side reforms and feed through to revenue forecasts”.
Think tank The Resolution Foundation say without much faster growth in the years ahead, the government is likely to need to announce fiscal tightening of between £37bn and £47bn in order for debt to be falling by 2026-27, the time-frame Kwarteng said he is committed to.
Their analysis said if Truss refuses to U-turn on tax cuts, then the spending cuts required “are broadly the same or bigger than George Osborne set out in his 2010 Emergency Budget”.
Torsten Bell, the foundation’s chief executive, said: “The Chancellor has eight weeks to decide which unpleasant combination of growth-reducing public investment cuts or income-reducing welfare cuts he is going to announce.”
Rhys Clyne, senior researcher at the Institute for Government, agreed that “It's going to be really difficult across the board”.
“There are no easy efficiencies, to use the language that the government seems to prefer, in the context of strained public service budgets anyway and in the effects of inflation," he told PoliticsHome.
“So we're not talking just about civil service cuts, we’re talking about departmental budgets, we're talking about the provision of public services, nurses, doctors, police, etc.”
Ben Zaranko, senior research economist at the IFS, felt the “scale of spending cuts required is really enormous and would have some really severe consequences for the state of and the quality of public services that we have”.
But he told PoliticsHome that it is unlikely such amounts could be found given the government ring-fences its biggest budgets.
“If you back yourself into a corner where you've said ‘I'm doing all these tax cuts, I'm going to protect the NHS budget, and I'm going to increase defence spending’, then basically there's not that much left that is available for you to cut,” he said.
With the cost of last week’s tax cuts considered to be at around £45bn, Zaranko said that is “five times the entire Ministry of Justice budget”.
“I just don't see any politically feasible way to raise money from spending cuts. I just don't think it's credible,” he said.
The IFS economist warned this is also the view the markets are likely to take, with planned cuts to spending likely to be pencilled in for the years beyond the current “speeding envelope” that runs to 2025, when there could be a potential Labour government in charge with entirely different priorities.
“It is perfectly possible that they'll pencil in some huge cuts between 2025 and 2028, but they probably won't be around to deliver them,” he said.
A poll on Thursday put Labour on a 33-point lead ahead of Tories, the largest margin in decades that would see the ruling party decimated if it were to be replicated at a general election.
Zaranko added: “ I think that the financial markets are probably in the mood of saying ‘show don’t tell’, they will want something more than just promises of unspecified spending cuts in four years’ time.”
He now considered there to be “a credibility gap”, between the government and markets, and that Truss and Kwarteng have “drank the Kool Aid and believed that everyone would back them in their big quest for growth”. The markets therefore do not see the UK’s economic credibility as “very healthy”.
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