Kleinwort Benson: WARNING- Economists are watching us.
|
|
THE June Emergency Budget in the UK has launched a major reversal in the direction of fiscal policy, moving from the enormous fiscal stimulus programmes of last year, to substantial fiscal restraint for the next five years. However, by imposing an extra £40bn of tightening (lower spending and higher taxes) on top of the £73bn that was already planned by the previous government, over the life of this parliament, the Chancellor is turning the UK economy into a live economic experiment. The £113bn total equates to a total tightening about 8% of the size of the economy over 5 years – historically very ambitious. As with Mrs Thatcher’s assault on government spending in the 1980s, all the “cuts” are in fact reductions in spending plans – in fact government spending is still expected to rise in every single year of this parliament, and be 11.5% higher by 2015/16 than the current financial year 2010/11. However, due to the rapid increase in government spending in previous years, the decline in the rate of future growth in spending will have a significant effect on the rate of growth of the economy as a whole. It is this which will be the subject of this experiment. This government is seeking a much more aggressive reduction of the budget deficit than the previous government did, and probably more than it needed to do to satisfy the financial markets. The clear risk to their strategy is that such a dramatic tightening damages demand in the economy so much that it sends it back into recession. The probability of this risk materialising rests on two factors – first what happens to the global economy and the prospects for exports, and second the size of the “fiscal multiplier”. A strong global economy would clearly help UK exports enormously – however over 50% of UK exports go to Europe which itself is engaging in major fiscal austerity. US economic prospects are a little brighter with continued population growth, a relatively healthy banking system, and as yet no drive to fiscal austerity. It is only in the emerging world where prospects still appear rosy – economies such as China and Brazil, have large populations with little debt, and a great desire to enjoy a higher standard of living. Overall the outlook for the global economy is mixed. The “fiscal multiplier” measures the degree to which changes in government spending impact the real economy. In justifying extra government spending at times of economic problems (as was the case in 2009), politicians implicitly assume that the fiscal multiplier is relatively high, so that the extra government spending encourages the private sector that the economic outlook is healthy so that they too spend more. By contrast in the latest UK budget with its huge fiscal tightening, this government is assuming the fiscal multiplier to be relatively low, so that a reduction in government spending actually has relatively little impact on the private sector’s decisions to spend. Thus economists now have the luxury of observing a real-time economic experiment into the size of the fiscal multiplier in the UK. If the government is wrong, then the scale of the tightening will send the UK economy into a period of weak growth or recession, which will make it very difficult to actually reduce the budget deficit. There appears to be no Plan B if this does occur. On the other hand, if the government is correct, then a renewed and better balanced UK economy could be the result in a few years time, with a much stronger focus on export and investment demand. This note is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy. They do not necessarily reflect the current investment policy of Kleinwort Benson. This note is intended for information purposes only and does not take into account the investment objective, the financial situation, or the individual needs of any particular person. Investors should obtain independent advice based on their own particular circumstances before making investment decisions. More articles in
Sectors
CommentsIf you'd like to leave a comment, please register now for free or login
|
