Policy constraints on UK/SW
growth in the 2010s
Professor John Hudson
University of Bath
Fiscal Policy and the Multiplier
Fiscal Policy involves the use of
government spending and tax rates to
control the economy at a macro level.
For example if growth is low and
unemployment high either taxes can be
cut of government spending can be
Both will increase GDP. What is more
there is a multiplier effect at work.
Thus if the Government increases road
building by £1 billion this will add to the
economy and road builders wages who in
turn will spend that money on consumer
goods, e.g. eating out.
This will then add to the income of the
waiters and cooks who in turn will spend
some of that income.
The impact on taxes
Potentially at least – there has been a
debate on this for 50 odd years – GDP will
increase by more than the £1 billion
Similarly the net cost to the government
will be less than £1 billion because of
increased tax revenue.
• For me the main surprise in the last 2
years is the extent to which the
government (many many governments)
were willing to spend and increase the
money supply to protect the economy, not
from recession but depression.
This has led to:
Rising Public Debt
The debt problem has been exacerbated
by falling government revenue from lower
incomes and falling asset prices (reduced
Thus one forecast is, even with corrective
measures in place, that the government
debt will approach 100% of GDP by 2014
General Government Debt % GDP
2007 2010 2014
France 63.8 85.4 96.3
Germany 63.4 84.5 89.3
India 80.5 85.9 78.6
Japan 187.7 227.0 245.6
UK 44.1 81.7 98.3
USA 61.9 93.6 108.2
Source IMF October 2009
People may say we are only a little worse than
France, but it is the speed we have got there
which causes concern.
Now the Reckoning
But we live in an unforgiving world ruled
not by governments but the market. There
is a limit to how far governments can
borrow, before the market gets nervous
and starts to raise interest rates.
This is what Greece has just discovered.
Credit Default Swaps (CDS)
Part of the risk can be perceived from
looking at these. They are a derivative,
relating to the riskiness of an asset.
With respect to sovereign (i.e. country)
debt they are an indication of the riskiness
of the country, on the probability of it
defaulting on its debt.
This indicates that the UK is viewed as
more risky than most OECD nations.
Although not quite on a par with
Greece, Spain and Portugal.
This is why government cuts and
tax increases are under way (IFS)
Planned Revenue Changes since
From April 2010, a 50p rate of income tax on income above
£150,000 and withdrawal of the personal allowance (PA) from
incomes above £100,000,
from April 2011, restriction of tax relief on their pension contributions
for anyone who saves in a pension whose gross income is above
£130,000 and whose income plus any employer pension
contributions is assessed to be over £150,000;
from April 2011, a 1p rise in employee and employer rates of
National Insurance (NI), with an increase in the point at which NI is
paid benefiting lower earners;
above-inflation increases in fuel duties each April to 2013 affecting
Plans to cut expenditure are more vague although
we can see some evidence in university and local
government cuts (IFS)
Below is one forecast of what will
happen to the debt burden (IFS)
Why the scenarios?
In this case because of the potential impact of
the debt burden on the interest rates we will
have to pay.
The IMF estimate that a persistent increase in
debt of about 20 percent of GDP would raise
debt service costs by more than 1½ percent of
GDP in G-20 countries.
This is what the different scenarios represent.
Still Too Optimistic?
It is based on annual growth of well above
2% pa and I do not believe that is
It is not clear whether this fully takes
account of the aging of the population
which will reduce income and raise
Risks as perceived by IMF
At a minimum, there is a risk that the public debt
issuance in the coming years could crowd out
private sector credit growth, gradually raising
interest rates for private borrowers and putting a
drag on the economic recovery.
A more serious risk is from a rapid increase in
interest rates on public debt.
Finally, there is the risk of a substantial loss in
investor confidence in some sovereign issuers,
with negative implications for economic growth
and credit performance in the affected countries.
So whoever wins the election cuts
will be made!
Although there may be differences at the margin
whichever party is in power we are likely to see taxes
rise and public sector spending fall.
Conventional wisdom too suggests that governments like
to get the nasty things out the way early in its life, hoping
it will reap benefits later when we approach an election.
There will be sharp cuts and tax rises in 2011 at the
latest and the strong possibility exists that they will be
substantially more severe than already announced.
Even if government spending overall would stay
constant, increasing debt repayments mean cuts have to
be made elsewhere.
What will be cut?
The situation is so serious I see few red
lines lasting for more than one or two
Everything that can be cut will be cut.
Defence. The UK’s world role will have to
be scaled down. We will have to, if we
want to retain influence, work within the
framework of allies.
G a rk
2006 o r latest available year
N Fi n
ew nl a
Law & order & Defence
a k ga
expenditure as a % of GDP
Public health spending % of GDP,
not that high, but the share of the
public sector is!
All taxes will be under threat to rise, including
VAT and income tax.
But in a competitive market place governments
may be constrained in terms of how out of line
with neighbouring countries the tax structure
gets, both VAT and income taxes.
Carbon taxes will be particularly vulnerable to
increases as they allow the government to
pretend it is for environmental reasons.
Further Negative Impacts on
North Sea oil is running out,
The long-term future of the UK as a
financial centre is not clear
The UK is not an ideal base for
manufacturing with low cost competitors
attracting firms who were previously based
in the UK (Cadburys at Keynsham going to
Poland is just one example).
Interest rates to rise (will impact on local
authority debt repayments)
University fees to rise considerably
The retirement age increased within the
next five years
Total Final Demand:
= C ↓? + I ↓? + G ↓ + X ↑?
Keynesian policy in reverse.
• The tax rises will impact negatively on
Governments will cut spending and this will cut
• Investment will be held back because of a
sluggish economy and rising interest rates.
• Then there is the multiplier, but the multiplier in
reverse gear. Expenditure cuts will have
multiplier effects causing further cuts in GDP.
The economist’s & political debate
Cut hard now and risk going back into
Cut later with the risk of interest rates
rising, but with the hope that the economy
‘has built up sufficient momentum’ not to
go back into recession when the cuts
Not an argument about if to cut, but when.
The SW Risks
Areas around military bases
The car industry around Swindon
Because of the financial crisis per se, the financial
sector in the SW particularly Bristol and
Because of the multiplier effects and consumer
cutbacks as well as retail trends, the retail sector
including the new shopping centres at risk
Marine engineering may be susceptible to the
planned tax increases focused on those with
incomes greater than £100,000 pa.
The SW Risks
Transport projects will be hit, maybe even some
currently in the pipeline cancelled. Particularly
bad news for remoter areas of region.
Construction industry in the doldrums.
At some time the pension crisis may bite hitting
the retirees in the region.
There is increasing pressure on the caring
sector with the rising elderly population, but
pressure on resources.
AND of course all the public sector, health,
education, local authorities, weather centres….
The SW: Optimism?
Food & drink
How Long will the problems last?
Japan has been caught in an economic
crisis, and indeed political crisis, since the
early 1990s, almost two decades.
I do not see economic situation getting
better in the next five years.
But I believe we will not resolve the
problems for at least a decade. Beyond
that is too far to see.
Only part of the picture
The public debt problem comes at a time when the UK
economy has substantial structural problems.
We need to reorientate the economy to replace the
In this respect we should not be cutting back on our
research capacity and attempting to encourage
We also need to focus on the education deficit in
particular those who have already graduated with too
Government spending should be focused on promoting
the competitiveness of the UK economy.
Investment in knowledge % GDP –
not good enough.
My forecast: UK growth to average
under 2% p.a. in 2010s.
In this we have focused on fiscal and
monetary policy, but…
Regulation, including environmental
regulation, imposed on firms slows down
growth in the short term at least.
That includes of course regulation aimed
at the financial sector.
Also quantitative easing may lead to
inflation over the next five years.