THE DEFICIT - CUTTING VOLUME OR PRICE - SPEED MATTERS

The three main parties have promised to cut government spending while not ‘hampering the recovery’.  Much has been said about cutting waste but the politicians have not been forthcoming in pointing out that many people get their income from carrying out wasteful jobs in the public sector or by being the beneficiary of wasteful welfare programmes.

So, how to cut?  Each and every item of government expenditure is a combination of volume and price.  So, reducing government expenditure requires an examination of the volume of government spending, the actual activities carried out, the numbers of government employees and welfare beneficiaries, as well as the prices of such spending, that is, the wage rates of employees and the benefit rates of the beneficiaries.

SPEED MATTERS – UNDERKILL AND OVERKILL

As Ken Clarke says, “The bond market will not wait for all the discussions and horse-trading”.

Quite.  Speed really is important.  The government needs to get “ahead of market expectations”, as Hamish McRae puts it in The Independent.

But exact accounting also matters.  As John Hoskyns, Margaret Thatcher’s policy adviser, put it in the crisis of 1981, “The penalties for erring too far on the side of underkill would be fatal … Those from erring on the side of overkill are, by comparison, relatively trivial.”

CUTTING PRICES

There is no doubt that there could be massive reductions in government spending in volume both in the number of its employees as well as the range of its activities.  Whether any particular part of this volume of spending is ‘wasteful’ is a matter of judgement.  Where specific government activities can be easily identified as ‘wasteful’ they should certainly be cut.

However, when seeking reduction in public expenditure, it is much quicker and much more exact in accounting terms to cut the prices (that is, wage rates and benefit rates) of the public sector.

In cutting the deficit and eventually cutting the debt mountain, speed and exact accounting to the desired total of deficit reduction are most important.  Quick action brings the deficit under control more immediately and clear and easily understandable tables of spending reduction reassure potential lenders that there is control of the situation.  Greece shows how slow-moving government has allowed a situation to run out of control.

That is why the May Committee in 1931 recommended percentage cuts in employee pay and unemployment pay.  The reductions in employee pay were accepted by the Labour government but disagreements over cuts in unemployment pay at a time when prices were falling, caused the collapse of Ramsay MacDonald’s government.

Also, the recent Irish budget mostly concentrated on cuts in price, the prices offered public sector workers to work for the government and the price offered to welfare beneficiaries.  Similar cuts have been carried out in Taiwan and Singapore to ministers’ and civil servants’ pay and rewards.  Cuts of 16 per cent in public sector pay and pensions and general pensions form part of the Greek emergency budget, May 2010.

Such reductions in prices are usually applied with bigger reductions for higher earners and beneficiaries and lower cuts for those with lower incomes and benefits.

THE PROCESS OF CUTTING PRICES

Cutting prices in the public sector is rather easy.  First, it is totally within government control.  Second, the needed reduction is factored over the total of government pay and welfare activities, including pensions, health and education, but excluding interest.  The total of pay of public sector employees and the benefits paid to beneficiaries can be simply obtained and the necessary percentage cut applied or a series of different percentage cuts, depending on political judgment.  The accounting can be quite exact.  In the present situation, an average cut of 15 per cent on the prices offered to employees and beneficiaries would bring the deficit down by approximately £75 billion.  This cut should simply be made on a take it or leave it basis.  Third, in the computer age the cuts can be made immediately as the computers are reset – the Irish did it in six weeks.

There will, of course, be some public sector employees and some welfare beneficiaries who decide they do not want to remain as employees or welfare beneficiaries on the lower prices now being offered and will transfer to the market sector.  That means that price reductions will also trigger a reduction in the volume of spending and will mean an increased supply of factors especially labour transferring to the market sector.  That is exactly what is needed.

Moreover, cuts in the prices offered to government employees or welfare beneficiaries will cause a ripple effect putting downward pressure on the prices offered by those who supply government employees or welfare beneficiaries not only in the retail sector but also to, say, landlords supplying housing to welfare beneficiaries.

There are also plenty of public sector employees who are anxious to retain their jobs and will prefer a cut in their pay rather than be dismissed and face unemployment.  Public sector pay is some 11 per cent higher than the private sector in cash wages and is at least double that (say, 20 per cent plus) when the hidden benefits of public sector employment are taken into account.  In the three months to February private sector pay increased by 1.8 per cent while public sector pay increased by 3.7 per cent.

An offer to reduce price rather than volume will be easier to sell as no-one will be forced out of their job or see their welfare benefits totally taken away, although as mentioned above, some will decide to transfer to the private market sector.

CUTTING VOLUME

Cutting the volume of government spending is a daunting and slow process, as Kenneth Clarke acknowledged.

Every single part of spending has to be examined and reviewed and decisions made on which activities to dispense with.  Simply identifying ‘wasteful’ expenditure is itself an enormous, ongoing and never-ending task.

In theory, it would be wonderful to go through every piece of government spending line by line ranking them as necessary or wasteful and cutting the wasteful items out.

The first problem is that when you have done all this, there is no certainty that the wasteful or less valuable activities that are recommended for cuts will total the overall cuts required.  If they do not, the whole process has to be gone through again and again.  More likely, the bureaucracy will offer various choices of what is to be cut, based on the least disturbance and the least irritation to the politically powerful.

Second, there are numerous vested interests, termination and cancellation payments and consequent reductions in services to be considered.

Third, even when labour is finally released, it is not necessarily the marginal activities which are closed down, it is arbitrary swathes of the public sector which are closed by political decision and which do not have the necessary political clout to resist.  It is unlikely that, for example, the pay and perquisites of MPs and their staff are likely to be the first ‘wasteful’ expenditure to be reduced.

Nor will there be cuts in payments to the EU since the EU has sensibly protected its income by legal treaty arrangements about which British politicians do not want to be seen to be unco-operative.  In fact, they have got themselves into a situation where they have to borrow from foreign sources to pay the British share of the EU budget.

None of this is to say that there should not be a relentless continuous effort to reduce the volume of expenditure, wasteful or not.

The question is – can it be done quickly and will it amount to the desired total of deficit reduction?

THE PROPOSALS OF THE POLITICAL PARTIES

All three political parties have promised to make immensely difficult and arithmetically uncertain cuts in the volume of government spending, although they have not named the proposed items.  They have, except for a couple of trivial items, including reducing ministers’ pay by five per cent, ignored the quicker, easier and more certain route of cutting prices.

Whatever government is elected will find that cutting volume in government activity is a lengthy, disputatious and uncertain process.  The danger is that the whole exercise will unravel and emphasis will move from cutting government spending to raising taxes.

This is much more likely to happen if potential lenders lose faith in what is an interminable process.  In the real world, while the Irish government’s bold action to cut prices worked and restored confidence, the Greek government’s inability to cut spending led to disaster.

There is one last hope before the current weakness of politicians to address the ‘financing gap’ means the IMF is brought in – an immediate price cut to all government spending plus volume cuts where possible.

FUTURUS/29 May 2010