We must learn from Canada and Sweden
THEY took their time but all British political parties have now bowed to the inevitable: spending cuts. With the budget deficit hitting at least 12 per cent of GDP, and the national debt about to spiral out of control, even Gordon Brown was forced yesterday to admit that his government would have to “cut costs, cut inefficiencies, cut unnecessary programmes and cut lower-priority budgets”.
The good news is that several countries have previously managed to push through the sorts of cuts that the UK will need over the next five years. My favourite is Canada; the other case study is Sweden. Canada achieved this through a sharp reduction in real spending, together with a return to strong real economic growth (which further depressed state spending as a share of national income). Sweden also put up taxes a little.
In 1992, Canada’s budget deficit reached 9.1 per cent of GDP. Just five years later, the country was boasting a budget surplus, in a dramatic turnaround we must learn to emulate. Between 1992 and 1997, spending fell by 9 percentage points of GDP, while tax rose by just 0.3 percentage points. Growth recovered from -2.1 per cent in 1991 to an average of 2.8 per cent growth during 1992-1997. It is easier for governments to cut spending in real terms when inflation runs rampant; yet consumer price rises slowed from 5.6 per cent in 1991 to just 1.5 per cent between 1992 and 1997.
Federal departmental budgets were reduced by 20 per cent on average within four years. Other areas did see spending growth, but on average total spending rose by only 0.7 per cent a year between 1992-1997 in cash terms, translating into an annual cut in real terms of around 0.8 per cent (once stripping out the effects of consumer price inflation).
How does this compare to the UK? Under the aspirations contained in Alistair Darling’s deeply flawed April Budget, total government spending would be roughly frozen between 2011-14 in real terms, a very different proposition. In nominal terms, spending would increase by roughly the rate of inflation. So what we now need to see from the Tories is a plan to limit growth in cash terms to between 0.5 and 1 per cent a year, ensuring large cuts in real terms and as a share of national income.
And what of the Swedish model? The seminal work here comes from Jens Henriksson. He points out that in 1994, the OECD projected that Swedish public debt would explode and that it would hit 128 percent of GDP by 2000. Thanks to swingeing spending cuts and unfortunately also higher taxes, the outcome was just 53 per cent of GDP. The budget deficit, which in 1994 peaked at 9.3 per cent of GDP, turned into a surplus of 1.9 percent four years later. No less than 11 per cent was cut from all government expenditure, with a few exceptions. Between 1994 and 1998 spending fell by 9.5 per cent of GDP; revenues rose by 1.7 per cent of GDP. So 85 per cent of the gain came from lower spending and 15 per cent from higher taxes.
While I prefer the Canadian model, this wasn’t bad either. We are likely to get something more akin to the Swedish solution in Britain – if the Tories are serious, that is. I welcome George Osborne’s announcement yesterday that he will call an emergency budget when he gets into office; he certainly has his work cut out.