UK Government Cuts Spending: Theories and Effects - Case Study Example

UK GOVERNMENT CUTS SPENDING: THEORIES AND EFFECTS by 19 August UK Government Cuts Spending: Theories and Effects The past financial crisis became a good test to the stability of economic and financial systems in the United Kingdom. The UK finally came to realize the seriousness of its budgetary constraints and an urgent need to restructure its attitudes toward government spending. Actually, government spending has become the major target of economic reforms in 2010: on May 24, 2010 the UK government announced the major areas which the decision to cut spending would touch. Transport, education, work and pensions, culture, law and environment officials are the first to experience the effects of reduced government spending. Excessive government spending is believed to negatively influence economic growth incentives and labor productivity; simultaneously, government spending is needed to support the most problematic economic sectors, including welfare, education, transport, and health. Until today, the effects of reduced government spending in the UK have been more negative than positive, resulting in lower business confidence, increased unemployment in the government sector, problems in the building sector recovery, and the lack of resources in transport, education, and health. Government spending and economic growth: Theoretical principles That government spending and macroeconomic growth are closely related cannot be denied. Government spending contributes to the growth of the most problematic economic sectors and serves an effective macroeconomic supportive mechanism. Needless to say, education, healthcare, transport, and welfare are all the products of wise government spending. Objectively, no matter how free market economies can be, they are impossible without government spending and government support. Ultimately, government spending is the critical element of any GDP. However, is government spending always beneficial and desired? Economic growth is the result of numerous economic efforts and decisions, the product of hundreds of companies and individual entrepreneurs working in and for the country. Economic growth is necessarily the product of governmental and individual attempts to develop and implement effective macroeconomic policies and decisions, which should sustain the balance of governmental control and free market principles in the economy. One cannot deny that “to ensure well-functioning markets, government must expend resources to enforce contracts, provide national security, and protect against criminals. Increased government expenditures, above this minimal level, have a diminishing effect on the growth of the economy” (Saxton 1995). Government spending has a potential to reduce incentives in the labor market: government spending discourages low productivity workers from looking for prospective employment and further aggravate the problem of government spending. Government spending reduces productivity in the major economic sectors – under the influence of governments, businesses cannot make objective decisions and fail to catch up with the market changes; as a result, they become less competitive and less productive (Saxton 1995). Finally, the more governments seek to impose their decisions on individuals and businesses, the more rent-seeking these individuals and businesses will become (Saxton 1995). Rent seeking hinders normal economic growth as long as it is used to manipulate limited resources for personal gain. These, however, are the extreme cases of government spending. More often than not, developed economies succeed in maintaining a reasonable balance of market freedom and government decisions. The reduction of government spending often becomes the measure of the last resort for the governments, which find it difficult to cope with the emerging financial and economic difficulties. The last economic crisis hit the stability of the British economy. As a result, economic and government officials chose to cut government spending. Unfortunately, the effects of this decision have been mostly negative. UK government cuts spending: Targets and effects On May 24, 2010 George Osborne, the Chancellor, announced plans for the rapid £6.25 billion cut in public spending (Collins 2010). The key areas to suffer reduced spending the Chancellor considers as wasteful: these include transport, business and education, culture, media and sport, communities and local government, law and justice departments, environment, energy, and climate change (Collins 2010). Actually, transport, business, education, and work and pensions are among the basic targets of the government spending cut – the Chancellor expected that the reduction of government spending in those areas would save around £2,724 million (Collins 2010). Unfortunately, business was the first to suffer the negative effects of reduced government spending. According to Pimlott (2010), the sharper spending cuts announced by the UK government led to the sharp decrease in business confidence over the last several months. While business confidence is falling, businessmen ascribe their problems and increased nervousness to the discussed reductions in government spending (Pimlott 2010). “Many businesses linked the decline in confidence to the planned cuts in public spending, which were expected to lead to weaker demand, both directly in those sectors with significant public sector exposure, and indirectly by reducing public sector employment and hence household income” (Pimlott 2010). Obviously, the cuts in government spending would not change businesses’ plans to increase productivity, to expand their consumer base, and to promote their products and services in the market, but decreased confidence produced a marked negative effect on the quality of business performance, especially for smaller businessmen. In this situation, business prefer not to make rapid strategic moves and choose to wait, to see the new direction of the government policies and to evaluate the future of the economic decisions made by the government. In broader contexts, the decision to cut government spending creates an atmosphere of confidence and slows down economic growth, until businesses have a better understanding of the new government policies and decisions. In this situation, customers choose to wait, too. On the one hand, customers are awaiting the major business decisions with regard to the discussed government spending cuts. On the other hand, because many customers work in public sector, they need time to see how the government’s decision to cut spending influences their jobs. Surprisingly or not, but the drop in business confidence is even larger than during the months of the deepest recession (Pimlott 2010). Businesses perceive the negative consequences of the government spending cuts coming from all aspects of business performance: customers put off the major purchases; businesses wait to see how reduced government spending influences markets; the government sector cancels numerous projects, making the signs of damaged confidence even more explicit (Pimlott 2010). Bank governors are confident that the decrease in business confidence and its negative effects on economy and markets are readily offset by the economic benefits of the new policy decisions – as a result of reduced government spending, the country was able to preserve the current state of interest rates and to provide private businesses with a new stimuli to grow and expand (Pimlott 2010). Unfortunately, it is difficult for businesses to grow in the atmosphere, when customers refuse to purchase product and services and the public sector cancels numerous contracts with private businesses. The exact financial and non-material losses of such reduction are difficult to underestimate. It should be noted, that the second quarter of 2010 in the UK was marked with unprecedented economic growth, the fastest since 2001; strong manufacturing figures indicated that the UK was slowly approaching a new positive point in its economic history. Now, however, it is difficult to predict how businesses will operate during the next several months. Given the role which business and entrepreneurship play in economic growth and recovery, one might expect that the loss of business confidence will become the beginning in the subsequent series of economic failures. As of today, the decision to cut government spending works against businesses and individual entrepreneurs. That consumers feel increasingly unconfident with regard to the major purchases is easy to understand: many of them work in public sector and feel that the reduction of government spending poses a direct threat to their employment. Their fears are well-grounded and justified: the discussed cut in government spending is likely to result in the loss of 725,000 jobs in the public sector (Shilton 2010). Professionals and scholars in economics predict that by 2012, Britain will fire 6 million public sector workers across the country, raising unemployment to 12 percent of the total workforce (Shilton 2010). These levels of unemployment will remain unchanged until the end of the current government in 2015 (Shilton 2010). In 2010 alone, almost 50,000 public sector jobs are to be eliminated to meet the goals of the government spending cut policy in the UK (Shilton 2010). Needless to say, the effects of the growing unemployment on British economy are likely to be tragic. Unemployment is directly related to the number of citizens on welfare: the lower the percentage of the unemployed is the more productive economy will be and the less effort the government will require to balance financial welfare costs with the economic losses caused by unemployment. In this situation, northern England, south Wales, Northern Ireland and Scotland are among the first to face the challenging consequences of the government’s economic decisions: throughout the last decades, these British regions depended to a greater extent on the public policy jobs (Shilton 2010). The decision to cut public sector spending and, consequentially, public sector jobs will create the so-called “north-south” divide, expanding the social and economic disparities between these two parts of one and the same country (Shilton 2010). In this situation, it is difficult to tell what the government sought to achieve by cutting public sector spending and reducing the number of public sector jobs. One does not need sophisticated knowledge of macroeconomics to understand, that unemployment increases will automatically cause the amount of the government welfare payments to rise. As such, the financial savings resulting from reduced government spending are, most likely, to be minimal. More importantly, rising unemployment may easily become the source of the major social conflicts – if imposed too harshly, government spending cuts are likely to lead to the development of broad-based social disagreement campaigns (Shilton 2010). The latter will become a clear warning to the current government that their economic measures provoke public disagreement and social conflicts. The reduction of spending by the levels offered by government is dangerous to millions of employees outside the public sector: Britain employs an estimated 1.7 million of employees contracted by numerous public sector services, including cleaning, refuse collection, and even providing school meals (Shilton 2010). The country’s transport sector relies heavily on government subsidies (Shilton 2010). Contracts will reduce, while the absence of subsidies will make it difficult for the transport and other sector to maintain the current number of employees. In this situation, private businesses will, most probably, experience a double hit: from the decreasing number of consumer spending due to unemployment and the decreased number of public contracts. As such, businesses, too, will need to lay off some of their employees to balance reduced profits with their labor costs. Reduced welfare spending and the government’s decision to cut financial benefits will exacerbate the existing situation and make people carry financial responsibility for the crisis, which they never caused. Apart from the fact that the decision to cut government spending in the UK hits business confidence and employment, certain industries and economic sectors are particularly vulnerable to the negative consequences of these cuts. Building sector recovery is under a serious threat: “the drop in government spending on new schools, hospitals and prisons has started to take a toll on building companies, dashing hopes for a sustained recovery in the sector” (Hammond & Cohen 2010). During the past year, building came to realize the financial potential of the public sector contracts and shifted the emphasis from the private to the public sector. As a result, the decision to cut government spending immediately reflected in steady decline of workloads in the building sector, posing a threat to the economic stability and employment of the whole industry (Hammond & Cohen 2010). Today, the construction industry accounts for nearly 10 percent of British GDP and employs more than 2 million of people (Hammond & Cohen 2010). The building sector had been strong enough to survive the 12 percent slump in business activity in 2009, but the new failure is likely to come from the weak demand for new public sector buildings, including offices and industrial buildings (Hammond & Cohen 2010). Again, and like many other businesses, the building sector is suffering the consequences of the decreasing consumer confidence and spending, as well as the growing uncertainty in the economy in general (Hammond & Cohen 2010). Given the seriousness of the economic situation in the UK, it is high time the government reconsidered its policy decisions before they turn into another economic tragedy. Conclusion In May 2010, the UK government announced its decision to dramatically cut government spending. The government anticipates billions of pounds to be saved as a result of proposed spending cuts. Business, education, welfare and pensions, transport and culture are the first to suffer the effects of reduced government spending. In many aspects, the decision to cut government spending was the measure of the last resort in the government’s striving to stimulate further economic growth and reduce its budget deficits. Unfortunately, as of today, the effects of this policy decision on the macroeconomic and microeconomic situation have been mostly negative. The loss of business confidence and the growing economic uncertainty are, probably, the most serious consequences of the proposed government spending cuts. The growing unemployment in the public and private sectors pose a serious threat to the macroeconomic stability in the country. Consumers are growing uncertain; private businesses are losing their public sector contracts; thousands of public sector employees risk becoming unemployed. Given the seriousness of the situation, it is high time the UK government reconsidered its policy decisions before they turn into another economic tragedy. References Collins, N 2010, ‘Government spending cuts: In summary’, The Telegraph, 14 May, accessed online, http://www.telegraph.co.uk/news/newstopics/politics/7759398/Government-spending-cuts-in-summary.html Hammond, E & Cohen, N 2010, ‘Spending cuts hit building sector recovery’, Financial Times, 17 August, accessed online, http://www.ft.com/cms/s/0/a827fdd8-aa1e-11df-9367-00144feabdc0,dwp_uuid=ec12e25a-624a-11de-b1c9-00144feabdc0.html Pimlott, D 2010, ‘Cutbacks his business confidence’, Financial Times, 18 August, accessed online, http://www.ft.com/cms/s/0/5ae9652c-aaa3-11df-80f9-00144feabdc0,dwp_uuid=ec12e25a-624a-11de-b1c9-00144feabdc0.html Saxton, J 1995, ‘Government spending and economic growth’, Joint Economic Committee, accessed online, http://www.house.gov/jec/fiscal/budget/spending/spending.htm Shilton, J 2010, ‘UK government spending cuts threaten over 700,000 jobs’, World Socialist Web Site, accessed online, http://www.wsws.org/articles/2010/jun2010/brit-j14.shtml Read More