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G20 implications on the UK’s economic recovery

30th June 2010 in News

The UK went into the G20 having ticked all the right boxes with its “unpopular but unavoidable” Emergency Budget. The measures, which included the deepest spending cuts since the 1920s, have shaken the bond markets off Britain’s back with spending cuts of £113bn, tax rises of £29bn which will have the deficit crisis sorted by 2014.

The markets applauded the coalition Government’s measures to attack the £155bn deficit, Sterling rose, and gilt yields fell. The Government could not have asked for a better response than a renewed faith in both the currency and government debt especially with memories of the Greek crisis so fresh in the mind. As yields fall, debt servicing gets cheaper, and under the Government’s plans to cut the national debt, taxpayers will save £3bn on the annual interest bill due to the lower borrowing costs from the market.

However, a sustained global recovery is vital for the UK to have any chance of success in meeting its economic challenges. Therefore for our trade to grow requires other markets to grow and foreign consumers to buy UK goods. The Office for Budget Responsibility (OBR), the Chancellor’s new independent economic forecaster, expects trade to be the biggest single contributor to UK economic growth next year.

From 2012 onwards, the OBR expects growth in both exports and business investment to more than make up for weak growth in household spending and a fall in public sector spending.

Deficit reduction may have won over the bond market crowd but the UK needs growth to deliver the other half of the equation. Each of the G20 nations knows that sustainable recovery in the global economy needs to resume as quickly as possible but many countries have decided to take the more prudent approach to their deficits.

Europe and the US are Britain’s largest export markets, and the Eurozone debt crisis and austerity measures to address this issue will affect growth in the region which inevitably will mean that the UK will lose out on trade.

The outcome of the summit in Toronto will prove pivotal to Britain’s prospects for recovery What the G20 leaders need to achieve was to strike the right balance between acting with sufficient speed and toughness to satisfy markets that deficits will fall sharply without taking such harsh action that will affect a recovery which is still so fragile that it can be derailed.

Their view as set out in their communiqué however was that they had to implement more “sound fiscal finances are essential to sustain recovery, provide flexibility to respond to new shocks, ensure the capacity to meet the challenges of aging populations, and avoid leaving future generations with a legacy of deficits and debt. The path of adjustment must be carefully calibrated to sustain the recovery in private demand. There is a risk that synchronized fiscal adjustment across several major economies could adversely impact the recovery. There is also a risk that the failure to implement consolidation where necessary would undermine confidence and hamper growth. Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016”. There is a clear agreement on a synchronised fiscal adjustment in principle if not in degree.

The US will continue to be allowed to follow a less austere route however while Europe pares back. President Obama is worried that suffocating spending in Europe will do little to revive growth globally. This explains a certain amount of tailoring in the final communiqué. The deal was seen as a win for Germany’s Angela Merkel, who said halving national deficits by 2013 globally was “more than I expected.” She has taken the lead in the Eurozone austerity measures in her discussions over Greece and Spain and has announced public expenditure cuts in Germany itself. However, this has not gone down well with the German people.

So, we have a new change of direction from supporting economies through fiscal injection to fiscal austerity. The deal arrived by the G20 in Toronto is focused on cutting deficits quicker. Such reductions by the European markets are bound to have an effect on UK trade which will compound the difficulties that will be felt by its own austerity measures. But where else can economic growth be generated in the meantime Asia, an unlikely scenario given the UK being a net importer from that region.

Even if the Government privately admits it will never achieve the full scale of its planned cuts, there is still a huge amount to achieve. By the end of this Parliament, the chasm in public finances will have been reduced the Government argues but it will still be borrowing. The Government hopes the national debt will be increasing more slowly than the economy is growing, it will be able to shrink the size of the state without inflicting further austerity.

The OBR’s original forecasts at the time of the Emergency Budget were that 100,000 more people unemployed than previously expected. Then there was a leaked report from the Treasury suggested that the cutbacks could result in additional unemployment of up to 1.3 million. The OBR then changed its view and they reforecast saying that 600,000 jobs will go in the public sector. The Government believes these job losses will be offset by job gains in the private sector. However, the impact of the cuts will not only have an effect on the public sector but also of the knock-on effect on the private sector. There will be companies in sectors vulnerable to the public sector cuts and in all likelihood when the cuts are actually imposed, business failures in these areas will mount. The sectors most dependent on public spending, such as construction, IT, recruitment, business services and media, will perform less well than other parts of the economy like manufacturing and retail. Even if the UK avoids a double dip recession, it could experience a twin track recovery, with public sector-facing industries seeing higher rates of business failures than sectors which are less directly linked to government spending cuts.”

The Budget was also a bold attempt to rebalance the economy, undoing 13 years under Labour of growth in the public sector when public employees grew by over 1 million. The offset the Government argues comes from offering business the stimulus to thrive with Corporation Tax cut by 28pc to 24pc by 2014 and Labour’s “jobs tax increase” in National Insurance Contributions scrapped, making the UK more competitive than most of Europe for companies wanting to locate in the UK. These two tax measures alone will cost the Government more than £5bn in 2012. The rise in VAT from 17.5pc to 20pc, to raise £13bn, was used to offset these costs but will inevitably put a further burden on growth. The Government hopes to stimulate the private sector into replacing the lost demand from the public sector but is this enough with Europe going into a period of austerity and a real risk of increasing unemployment in the UK.

There is also a real threat of strikes from the larger unions operating in the public sector. “This Budget signals the battle for Britain’s public services has begun, with the Government declaring war,” said Dave Prentis, general secretary of Unison. Many unions are so entrenched in the public sector that the invoking the cuts will mean that large strike action by public sector workers look inevitable.

The G20 leaders are in line with the austerity policy which is necessary to satisfy the markets and reduce the risk of further problems such as Greece. But it is a gamble that it is too soon and too quick a change in policy and that by working in harmony in terms of the reductions it could have an even greater impact on the economic outcome.

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