The Daily Telegraph

Gear up for growth

Austerity has run its course Andrew Sentance

- ANDREW SENTANCE Andrew Sentance is senior economic adviser at PWC and a former member of the Monetary Policy Committee

Next month, we will reach the 10th anniversar­y of the first tremors of the global financial crisis. In July 2007, we saw the first signs that the availabili­ty of credit, market interest rates and share prices were being affected by the problems associated with sub-prime lending in the United States. A couple of months later, we saw the collapse of Northern Rock here in the UK. Just over a year later the crisis came to a climax with the failure of Lehman Brothers in September 2008.

The financial crisis – and the recession which followed – had serious consequenc­es for public finances in major economies around the world. Here in the UK, government borrowing rose to more than £150bn – around 10pc of GDP. This was the highest public sector deficit recorded since the Second World War, both in absolute terms and relative to the size of our economy.

There are only two ways to correct a deficit of this size. The first is to restrict public spending and the second is to raise taxes. In 2011, the coalition government raised the VAT rate to 20pc to help rein in public borrowing. But most of the heavy lifting to restore the health of public finances has been done by holding back the growth of public spending. In normal times, government expenditur­e will rise by around 2pc a year in real terms (adjusted for inflation) – roughly in line with the trend rate of growth in the economy. But since 2010, there has been virtually no growth in the real value of public spending – over a seven-year period. This has produced a saving of more than £100bn – and public borrowing has fallen by a roughly equivalent amount.

This process of restrictin­g government spending has become known as “austerity”. The word is somewhat misleading, as it implies that total public expenditur­e is being cut – which has not been the case. Budgets for some government department­s have had to be reduced to pay for increases in priority areas, including health and pensions – which were protected by the “triple lock”. On average, public expenditur­e has risen roughly in line with inflation over the past seven years.

However, this has created a very different spending climate from the decade that preceded it. In the 10 years before 2009-10, government expenditur­e rose in real terms by 4.6pc a year – more than double the trend rate of growth of the economy. Zero growth is a big shock to the system after a period of such strong public spending growth.

This has been the third period of austerity in the UK’S post-war history, and each has followed a major recession. In the late Seventies and early Eighties, Denis Healey and Geoffrey Howe were the austerity chancellor­s. In the Nineties, the challenge fell to Ken Clarke and his policies were continued into the first few years of Gordon Brown’s chancellor­ship. The burden of austerity fell on George Osborne this time around.

But austerity has now done its job. It has delivered what it said on the tin. The government deficit last year was just 2.5pc of GDP, just a quarter of its level in 2009-10. That is very close to the long-term average for the UK. Whether we look back 20, 30, 40 or 50 years, our average level of government borrowing comes out somewhere between 2pc and 2.5pc of GDP. It makes sense for a government to borrow money – to fund investment and other long-term projects. But the level of borrowing needs to be

‘It makes sense for a government to borrow money – to fund investment and long-term projects’

contained at a reasonable and modest level. According to the Office for Budget Responsibi­lity (OBR), the plans announced in the March Budget would reduce public borrowing to 0.7pc of GDP by 2021-22, the last full financial year of this Parliament (assuming it runs its full course). If the Chancellor adopted instead a borrowing target of 2pc of GDP for 2021-22, he could spend an extra £30bn a year by the end of the Government’s five-year term.

Alternativ­ely, he could deliver £30bn of tax cuts – equivalent to reducing the basic rate of tax by four pence in the pound. However, given that spending has borne the brunt of “austerity” so far, it would probably make sense to relax spending targets rather than make big tax cuts.

Where should Philip Hammond spend this extra money, if he is going to move to a less austere economic and financial policy? One key issue is the way in which pay has been held down for public sector workers – which is now creating a severe squeeze against the background of rising inflation. Allowing public sector pay to rise in line with private sector wages and inflation would help ease the pressure that workers in national and local government are feeling. It would also help with recruitmen­t and retention in the public sector.

In addition, the Chancellor should be allocating more resources to areas of government spending that support future economic growth – in particular investment in transport infrastruc­ture and skills. The skills agenda is particular­ly important as we face the prospect of a lower supply of workers from overseas because of tougher immigratio­n controls after Brexit. It is also the key to boosting the UK’S flagging productivi­ty growth rate. One of the most important levers the government has to boost productivi­ty levels is to ensure that businesses have access to the skilled workers that they need to expand and grow.

A neglected area of the UK’S skills agenda for many decades is vocational and technical education – investing in education and training for the majority of young people who do not go on to university. We should expand the scope for apprentice­ships and provide more funding for colleges of further education. Many further education colleges offer excellent quality teaching and training. A Government survey last week ranked the City of Liverpool College on a par with the University of Cambridge – delivering a gold standard quality of teaching.

The bottom line, however, is that austerity has run its course. We have reduced the government deficit to a sustainabl­e level and now is the time to focus tax and spending decisions on supporting economic growth. Shifting fiscal policy in this direction will help support the UK economy as we navigate through the uncertaint­ies of Brexit.

 ??  ?? Crunch time: the 2007 run on Northern Rock was the first on a UK bank for 100 years
Crunch time: the 2007 run on Northern Rock was the first on a UK bank for 100 years
 ??  ??

Newspapers in English

Newspapers from United Kingdom