Why business bosses are wrong about the cuts

by Ed Bowsher on 19 October 2010  |  16 comments
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Aggressive government spending cuts won't cut the deficit.

35 business leaders wrote to The Telegraph today supporting George Osborne's plans to eliminate the deficit in five years. The business leaders are wrong.  Here's why.

The bosses started their letter by saying it was a mistake to cut spending more slowly:

"The cost of delay would result in almost £100 billion of additional national debt by the end of this parliament alone. In the end, the result would be deeper cuts, or further tax rises, in order to pay for the extra debt interest."

The above statement assumes that spending cuts have no impact on the wider economy. If we're 100 per cent sure that the economy will grow at 2 per cent a year regardless of government spending plans, then the above statement is true. But that's a bonkers assumption. In reality, bigger cuts will mean lower economic growth, lower tax revenue, and a larger deficit than Osborne and the bosses expect.

In fairness, the bosses do respond to the growth argument:

"There is no reason to think that the pace of consolidation envisaged in the Budget will undermine the recovery.

"The private sector should be more than capable of generating additional jobs to replace those lost in the public sector, and the redeployment of people to more productive activities will improve economic performance, so generating more employment opportunities."

The roots of this claim are in an economic theory called 'crowding out.' The idea is that a large public sector funded by government borrowing can stifle the growth of the private sector. The government's borrowing drives up interest rates which makes it harder for businesses to grow.

Now I accept that crowding out can be a real problem in some scenarios, but it's not relevant to where we are now. The base rate is at  0.5%. Interest rates aren't the problem.

Businesses, families and individuals have been traumatised by the economic crisis and are paying down debt. That's why there isn't enough demand in the economy to drive growth. And it's why businesses aren't investing and growing at the rate one might hope for.

Laying off public sector workers isn't going to change this.  My boss isn't going to wake up one day and say to himself: "Great, half a milion public sector workers have been laid off, I'd better start growing lovemoney.com more quickly to take advantage of this opportunity."

Instead, we'll have a larger number of unemployed people who will spend less in the shops. That's not going to help the private sector.

Don't get me wrong. The deficit is unsustainably high. It must be reduced and spending cuts will play a role. But as Michael Portillo has said this week, growth is going to be our most effective weapon, so let's do everything we can to get economic growth back up to 3% year after year this decade.