The Economy is Not Like a Household Budget

The spending review is due to be published on the 20th October. It is expected to contain proposals that will significantly reduce public spending across the board. It is likely that the decisions made by the government are likely to affect the experiences of people in the UK for the next decade. Over the next couple of weeks, this blog is going to be focused upon the impact of spending cuts.

The main reason the government claims spending cuts are needed is its belief that the UK faces severe economic difficulties if the deficit isn’t tackled sooner rather than later. No doubt this is a view that will be challenged on here in the coming days, but for now I want to explain the differences between government finances and a household budget. Consider a household where expenditure is routinely more than income. Eventually the bills and debts mount up, and the household has to change its behaviour.

At first the household concerns makes some savings in its expenditure, they cut out the pub lunches and bring sandwiches to work, they stay at home on Saturdays instead of going out, they use price comparison sites, and perhaps they decide to holiday in the UK rather than go abroad. On the income side over the long run, they explore getting better paid jobs, and maybe sell some things they no longer need on ebay.

The government would like you to think that their economic policy is like that of the household above; for years it has been spending more than it earns, and now it is becoming necessary to put the finances in order. So it is going to cut out the pub lunches and luxuries, and replace them with the packed lunches and the supermarket value services. But this is just wrong; the finances of a government are not like a household. The choices the household above makes have a negligible effect on the rest of us, whereas the choices made by the government have a massive impact on the economy. Furthermore cutting out pub lunches hardly means you have to increase spending elsewhere in your budget.

This is because cutting spending in one area frequently leads to an increase in spending in another area. Even at the basic level this is clear, redundancy costs may have to be made to civil servants out of a job, welfare payments made until that person obtains new employment (perhaps with payments then needed from tax credits) and the tax take of that person drops. This is before we consider multiplier effects on the private sector (major job losses in one area will be followed by job losses elsewhere) and further increases in the cyclical deficit. The net result is a fiscal contraction. The case of Ireland illustrates this well; in 2009 its deficit was 12% of GDP, after it made sizable cuts its deficit remained at 12% of GDP in 2010 as its income collapsed and the cost of benefits rose.

However there is also a further effect, which is that if you stop a particular social programme, you have consequences that may mean further expenditure on other areas becomes necessary. If you stop spending money on schemes aimed at preventing young people turning to crime, then in future years you will be spending money on dealing with the criminals that result from the absence of those schemes. Cut a scheme that increases physical fitness in deprived communities and you spend the money on healthcare later on. Cut education provision and you get reduced income tax bills and higher unemployment bills later on.

In other words the economy is not like a household budget. Cutting the deficit isn’t about finding a list of project and schemes you will no longer spend money on, it is about deciding where savings can be made that are real savings and not merely shifts in expenditure. It is about not crippling the ability to obtain a future income, and not condemning communities to decades of deprivation. After all, nobody would suggest the household in debt balances its bank accounts by the main earner quitting their job in order to save money on petrol.

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