UK Budget Butchers Put Public Finances on the Chopping Block

Public finances are on the chopping block in England, but the butchers are using butter knifes and soup spoons. What’s needed is a well sharpened cleaver…and the steely resolve to bring the blade down.

Earlier this week, the UK’s new coalition government announced the first round of what might fairly be considered rather mild “austerity” measures for one of the world’s most indebted nations. Chancellor of the Exchequer George Osborne and the Chief Secretary to the Treasury David Law detailed their plan in the garden of Her Majesty’s Treasury on Monday.

According to The Wall Street Journal, the cuts “include £120 million from a civil-service recruitment freeze; about £1.15 billion in reductions from discretionary spending items such as consultancy fees and travel costs; and £1.7 billion from stopping projects and renegotiating large government contracts with suppliers. Local governments will be expected to find £1.17 billion in savings.”

All in, the measures aim at reducing Ol’ Blighty’s annual deficit by £6.25 billion. Impressive as that might sound, it is a drop in the pail when viewed next to the nations record-breaking £156 billion deficit for the most recent financial year. Expressed as a percentage of GDP (10.4%), the UK’s budget deficit is only fractionally “healthier” than those of Greece and Spain (11.2% and 13.6% respectively), both of which recently saw their sovereign credit ratings decapitated by typically late-on-the-scene ratings agencies.

To be fair, the early cuts are meant as a “down payment,” as Mr. Laws explained, to show government departments that “the years of public-sector plenty” are over. “These are only the first steps we’ll need to take in order to put our public finances back in shape,” he said.

Tough talk is a political prerequisite, of course, but it’s tough actions that ultimately count. Alas, such decisive actions are unlikely. In what is seen as a concession to Liberal Democrats, some £500 million of the coalition’s proposed savings will be siphoned right back into government welfare programs. Another £700 million in cuts to Scottish, Welsh and Northern Irish authorities aren’t due to take effect until 2011, far beyond the use-by date of most political promises. The government also vowed to protect spending on health care, defense and overseas aid budgets, adding that it will not take the knife to public school outlays and various other education programs.

It’s not difficult to understand why a new government would opt for a “softly softly” approach. Budgetary savings must be weighed against a cost to political capital. A dollar saved is a vote lost, in other words. Or something like that.

Of course, the state is never short of academics willing and eager to advise more and more spending, especially during recessionary or fragile economic landscapes. Keynesian interventionalists argue that withdrawing government support during downturns can hinder efforts to build a sustainable recovery. What they routinely forget, or misunderstand, is that state-sponsored “productivity” is not really productivity at all, but rather an opportunity cost to the private sector. A dollar spent hiring a post office clerk or, indeed, any molly-coddled rubber stamper is (at least) a dollar that real businesses can’t then put to better, more efficient use elsewhere. Although government spending shows up in the GDP figure as a net positive, it really ought to be tallied as a minus.

These agreements aside for the moment, the immediate impediment to slicing too deeply into public sector finances in countries like the UK is that so many citizens have their fingers on the cutting board.

Over the past thirteen years – since the Labor government first came to power in 1997 – the number of public sector employees increased in the UK by almost 1 million, with government jobs now accounting for more than one-fifth of the total workforce. Public sector wages are also rising at almost three times the pace as in the private sector and, last year, average compensation for state workers actually eclipsed that of their private sector counterparts. And that’s just the beginning. Public sector workers enjoy a bevy of additional financial and lifestyle advantages. On average, they retire 7 years earlier than those in the private sector, work fewer hours (35 per week), take three to four more paid days off annually and receive employer pension contributions worth 19.4% of their wages, more than three times the 6% average contributions afforded in the private workplace. And yet, despite these comparative advantages (or perhaps because of them) productivity in the UK’s public sector actually fell by 3.4% in the 10 years from 1997 – compared with an increase of 28% in the private sector over the same period.

Unfortunately for those seeking to push through spending cuts, it’s virtually impossible to get rid of a public employee once you’ve got one on the books. In the two years following the collapse of Northern Rock (seen by some as Britain’s “Lehman Bros. moment”) in late 2007, the state increased its workforce by some 300,000 members. The private sector, by contrast, took the axe to almost a million jobs last year alone.

Nevertheless, The Institute of Fiscal Studies, a British economic research institute, estimates government departments vulnerable to cutbacks will face reductions of 8.4% during the coming financial year. Our guess is that’s not going to go over well. As we’ve seen in Greece and, more recently, in Spain, workers without fingers have a tendency to march in the streets, burn buildings and cause social unrest. Indeed, before the recent election, Bank of England governor Mervyn King is said to have warned that any party seeking to enact ambitious spending cuts would face a public outrage so severe it would see them ousted from power for an entire generation.

Like their counterparts in neighboring, faltering Club Med economies, England’s would-be budget butchers have some tough choices to make in the coming months. Today the cleaver…tomorrow the guillotine.

Joel Bowman
for The Daily Reckoning

The Daily Reckoning