Going for broke

No one can deny that George Osborne has bottle.

No one can deny that George Osborne has bottle. The emergency budget presented on June 22nd by Britains new Conservative chancellor of the exchequer aims to deliver a whopping fiscal retrenchment equal to 6.3 per cent of GDP by 2014-15. Three-quarters of the adjustment will come from spending cuts,including cuts in welfare. The rest will come from tax hikes,both those planned by Labour and new ones,including notably a rise in the consumption-tax VAT rate. Government spending will fall from over 47 per cent of GDP in 2009-10 to under 41 per cent,and borrowing from 11 per cent of GDP to 2 per cent.

This is tough stuff,and the markets took it as such. Sterling and gilt-edged government bonds strengthened a bit; the credit-rating agencies expressed renewed confidence. The message that,at a time of worldwide jitters over sovereign debt,Britain is determined not to be classed with the likes of Greece is welcome. So is the balance of spending cuts and tax rises,and the reduction in the corporate-tax rate.

When promises should be broken

There are things to take issue with,though,small and big. Whether the budget is worse for poor people than for the better off is disputed,but Mr Osborne could have done more to counter the perception that it is for example,by means-testing benefits that go now to both. A chance was missed to redesign the tax system by,for instance,including a new carbon tax. And Mr Osborne should not have accepted inherited plans to trim capital spending by as much as 1.5 per cent of GDP; a growing economy needs modern roads,railways and the like.

But there are bigger difficulties. Can Mr Osborne deliver the savings he promises? If he does,will the economy stumble?

The single gravest error in this budget,and it is one that Mr Osborne will come to rue,was ring-fencing health. Granted,the Tories pledged before the election to maintain spending on the popular National Health Service. But health care absorbs almost a fifth of government spending,and it grew faster during the past decade than any other public service.

Walling off health means imposing enormous cuts on other departments,averaging 25 per cent by 2014-15 unless more savings are found in welfare. These will be difficult to pull off politically,not least because they expose divisions between the Tory and Liberal Democrat bits of the coalition. Without ring-fencing,the cuts would be 14 per cent. And there should be more emphasis on reforms to deliver services more efficiently,less on measures that smack of nickel-and-diming a received agenda.

The second question is whether the economy can take Mr Osbornes strong medicine if he can,in fact,administer it. He is proposing to knock 113 billion a year out of the deficit by 2014-15,40 billion more than his predecessor. Britain will grow,Mr Osborne reckons,if the state steps back: businesses will invest,exports expand,employment take off. The important thing is to avoid a growing debt burden,which would mean more savage cuts in services and welfare down the road.

Story continues below this ad

He is right to take that bet,but he should also be aware that it is a gamble and adjustment may be needed. Britains recovery from a savage,six-quarter recession has been far from robust. Excess capacity could dampen business investment,and so will banks continued reluctance to lend. Lower government spending and higher taxes will do little to enliven the domestic market,and the euro area,Britains main trading partner,is struggling. Against this backdrop,what matters is caution and flexibility. The increase in VAT,for example,is scheduled for January it could well be delayed if the economy takes a turn for the worse. Mr Osborne has shown that he has courage; wisdom dictates that he have a Plan B as well.