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Shock wave

There is no doubt that the government's binge spending has to stop.

The new government is talking about a shock wave of cuts, including eliminating chauffeur-driven cars for civil servants. By all means, but why do they say and do nothing about the vast sums sent as tribute to the EU? You and I know the answer to that question.

So exactly how will the government make cuts? Anthony Scholefield's timely E=PV tells us what government should be doing.

E=PV

by Anthony Scholefield

The financial hurricane which has been circling Europe for the last few days has forced more countries into cuts in the prices of government spending on wages and entitlements, and also some volume reductions in public spending.

Yet the British political and economic establishment does not seem to comprehend the basic expenditure equation:

E (expenditure) = PV (Price x Volume) and further that, as history shows, it is exceptionally difficult to make quick volume reductions and quite easy to make price reductions. Yet volume reductions in public expenditure are the establishment’s strategic choice. Failure to achieve substantial volume reductions is likely and will lead to hasty and massive tax increases.

Greece and After

Following the Irish budget and then the Eurozone package of aid to Greece which enforced price cuts, Spain is the latest country to find out that serious, quick public spending cuts can only be enforced by price cuts in government spending.

Mervyn King, Governor of the Bank of England, emphasised the need for speed in dealing with the deficit in his press conference of 13th May and cuts in the prices of government spending are the only way to effect swift action.

Highlights of the Spanish measures are:

- public sector salaries cut by five per cent;
- ministers’ pay cut by 15 per cent;
- all increases (including inflation adjustments) to pensions stopped.

The Coalition Plans Are Unrealistic

Yet, the new coalition government in London seems to regard such action as unnecessary.

The agreements, reached only on May 11th by the new ‘Liberal Conservative’ government, are already looking completely unrealistic.

These agreements, quite incredibly, contain a long list of proposals for increased spending. Even the £6 billion promised cuts in spending are qualified since some of them ‘can be used to support jobs’.

There is only one trivial proposal (reducing ministers’ salaries by five per cent) for reductions in the prices of government spending in wages and entitlements. This proposal is itself an example of ‘underkill’ when ‘overkill’ is required.

The rest of the cuts are vague, not yet fully agreed and appear to be concentrated on the much more intractable area of reducing the volume of government spending. There is a danger that this intractability will result in lack of action and in compensation, there well be a reach for quick tax rises. There is already a sense that there is a softening up process for tax increases.

As put by The Independent, 14th May 2010, ‘Spending cuts. . .may be difficult to actually implement. Don’t be surprised then if tax rises end up accounting for a greater part of the deficit reduction programme than the Conservatives had hoped’.

It seems that the government and its advisers do not understand the nature of the crisis and think that Britain does not have to make reductions in the prices of government spending although other high deficit countries are being forced to do so.

What happens next?

The cuts in the prices of government spending in Southern Europe may well deflect the bond market storm to the UK, aided by some unhelpful criticism of the UK’s fiscal position from within the eurozone. There is, however, some protection in the longer-term nature of British debt and the ability of the British government to let the pound fall in value.

However, the likelihood is that, at any time, the bond markets, acting for the interests of international savers and tax payers, will see that the coalition has no intention of reducing the prices of government spending, as now being enacted in Southern Europe, despite the greater size of the UK deficit.

The current agreements to increase spending in many areas and to promise vague cuts in volume spending will probably be overtaken by events and the sort of price cuts in public sector wages and entitlements proposed in Southern Europe will be forced on the UK.

Anthony Scholefield
Futurus

Suite 604 Linen Hall . 162 Regent Street . London W1B 5TG
Telephone/Fax: 020 7287 7277 Mobile: 07984 620187
email: anthony.scholefield@ntlworld.com

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