Monday, May 24, 2010

Public Sector Cuts and the 1990's

This post is a response to Sunny after a brief exchange on Twitter today on exactly how the left needs to deal with the new government's plans for cuts. For my part I disagree with Sunny's analysis that we should accept the need for cuts, I'm also not sure if it's a particularly good move politically since it plays right into the whole "Labour's Terrible Economic Inheritance" narrative the the new government is trying to spin to the media (I had a bit of a rant about this in my last post).

To see why, we need to take a look at the last recession in 1990 and how the deficit was resolved in that situation. To do this I'm using my favourite methof of late, a graph. The graph below show's the inflation adjusted change in public sector spending alongside the public sector net borrowing:

As you can see, the deficit shot up after the recession evenutally reaching a figure of just under 8%, this is an important point to start with because although it's smaller than the current deficit the two figures are not a million miles apart. The second point is that the Conservative government of the day dis not make cut's, in fact, they actually increased public spending as the recession went on.Further to this, we can see that the recovery in the deficit properly begins shortly after the largest increase in public spending.

My view is that the majority of the reduction in deficit will not come from public service cut's but from economic recovery, that certainly seems to have been the case in the 1990's (as the IMF says: Automatic Stabiliser's Work, Always and Everywhere). When the economy get's into difficulty, it is always tax revenues that take the largest hit, far larger than the actual dip in economic activity, when the economy recovers tax revenues also jump back up far faster. I believe this is the effect we are seeing at the moment as the recent deficit undershoot was nearly four times the size of this year's cuts.

There may be a need to hold back on spending in a few years time, but right now I don't think the left should be falling for this cuts argument.

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