Against the tide: What’s the UK’s exit strategy?
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Against the tide: What’s the UK’s exit strategy?

Gordon Brown’s government has no clear strategy for dealing with the budget deficit. Nor does its likely successor, the Conservatives led by David Cameron.

The G20 summit in Pittsburgh might well have publicly pledged again to continue with government bailout packages for the financial sector and fiscal stimulus programmes for economies still mired in recession. However, behind the scenes governments and central banks are thinking deeply about exit strategies.

The world economy is nowhere near recovering from the deepest recession since the Second World War. But there are signs that the worst is over – finally. I don’t expect any significant recovery, and certainly not one that is sustainable, until households have reduced their debt levels and started to save more; and banks have finally reconstituted their capital base and started to lend more to businesses still starved of credit.

But the risk is that such is the level of government debt now built up in G20 economies that it will stifle or crowd out the private sector from receiving the credit that it needs for growth. Public funds and central bank liquidity have provided the fuel for the stock market rally and the hope that the G20 economies are set to recover fast. But this largesse will have to be paid for by lower growth and/or higher inflation unless governments start to cut their deficits.

But nobody appears to have worked out an exit strategy. Take the UK. The New Labour government under Gordon Brown has been in denial. The Brown government claims that it needs to spend its way out of the slump and that then, once recovery is under way, it can still maintain increased real spending on public services.

Finally, leaked UK Treasury documents have shown that underneath the political blather, the bureaucrats have calculated that real cuts in public services of near 10% will be necessary over the next four years of a new parliament starting in 2010 if the budget deficit is to be brought under control and government debt is not to rocket above 100% of GDP. Overall public spending might still rise anyway because of increased debt charges and higher mandatory payments for the unemployed.

Of course, what the present government thinks might prove irrelevant because the Conservative opposition under David Cameron looks set to win the next UK general election, which must be called by May 2010. Will the exit strategy be any different under Cameron?

Investors can expect policies that are more business friendly. But there will be no Thatcher-type revolution in public finances and market deregulation. Cameron is more of an old-style "one nation" conservative.

The Conservative party has pledged to maintain current spending priorities, at least for the first year. Cameron is likely to avoid any immediate confrontation by ditching that commitment.

The Conservatives have adopted a new slogan, "progressive conservatism". While this is just a PR catchphrase, it has policy implications. It means that the party is pledged to maintaining high government spending.

Many of the party’s pledges are about rearranging spending targets, rather than necessarily cutting the amount the government spends. George Osborne, the party’s likely future finance minister, has spoken about welfare reform (which is unlikely to be less costly than the current welfare spending); the introduction of Swedish-style independent schools (which will do nothing to cut the spending on education); and spending more on defence, despite the fact that it is difficult to see how the defence budget can be made bigger.

Most important, the party has precious few ideas about the reform of the National Health Service, which consumes a huge chunk of expenditure. The Conservatives’ plan for the NHS – if it can be called a plan – is to grant "operational independence" to NHS managers. Ironically, this is a recipe for more rather than less spending.

None of these considerations necessarily means that, once in government, Cameron will not act differently. If the condition of UK finances continues to deteriorate and inflation starts to rise, the new government will simply have to tighten the spending screws.

But there is a limit to how much any government can change immediately. One-third of state spending is non-discretionary (social security benefits, tax credits and debt interest). If the health service and education are deemed sacrosanct and so not subject to cuts, that figure rises to 60%.

Cameron might turn out to be a radical leader but there is nothing in his behaviour to suggest this would happen overnight, if at all.

Government outlays as a percentage of GDP


Source: IFS

David Roche is president of Independent Strategy Ltd, a London-based research firm.

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