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Friday, June 18, 2010

Recipes for curbing deficits


LONDON — Following the Greek financial crisis, governments in Europe have been adopting austerity measures designed to reduce public sector deficits. The main reason that cuts in governments expenditure are needed is that unless clear and determined steps are taken to reduce public sector deficits, governments may no longer be able to borrow on reasonable terms and could ultimately default on their debts as was feared for Greece.

The countries with the highest public deficits in Europe have been Greece, Portugal, Ireland and Spain, the so-called PIGS. But other European countries with deficits higher than those permitted under the Maastricht Treaty include Italy, France and Germany among euro-zone countries, and Britain, which has not adopted the common currency.

Austerity measures forced on the Greek government have led to unrest and strikes by public sector workers.

There has also been trouble in Spain where the building boom has burst and where unemployment has reached 20 percent. Young workers have been particularly badly hit.

Stringent cuts made in Ireland seem to have been reluctantly accepted as necessary by the Irish whose economy had soared after Ireland was admitted to the EU. German austerity measures are less draconian than those of some other European countries, but Germany now has a constitutional requirement to move toward a balanced budget.

The new British government has expressed its determination to make cuts in public expenditure of £6 billion in the current fiscal year and will try to achieve much greater reductions in the years ahead. So far the cuts announced, such as reductions in ministerial cars and the requirement that civil servants traveling by rail should wherever possible travel second class, have been largely cosmetic, designed to make voters feel that ministers and bureaucrats will share the pain.

Ministers have looked hard at expenditures authorized by the last government in its final months to see how much of this was necessary and have found some projects to ax. The media have been digging out information about recruitment for "unnecessary" posts in central and local government and wasteful expenses on consultants and advisers. They have also drawn attention to posts in the public sector where bureaucrats are paid more than the prime minister.

The Labour government was suspicious of civil servants and decided to bring in more people from the outside at middle and senior management levels. To attract suitable candidates, they had to offer rates of pay comparable with those of the private sector. As a result, public sector wage costs rose to levels that attracted private sector criticism, particularly of public sector pensions linked to the cost of living.

The recruitment of outsiders at higher rates of pay and the sums paid to consultants undermined the morale of permanent members of the civil service. The last government spent too much on public relations, consultancy fees and quangos whose ranks were filled through patronage and whose functions were either ill-defined or overlapped with work being done elsewhere in government.

Cutting out waste is never easy and it will not be possible by penny-pinching measures alone to cure the public sector debt. This can be done only by reducing welfare benefits and eliminating programs that are nonessential or unaffordable in the short term.

Some argue that this is best done by cutting budgets overall by a defined percentage so that there is equal misery. Others argue for what seems to be the present government's policy of ring-fencing some budgets, such as those of the National Health Service and Overseas Aid.

Other promises have been made about protecting old-age pensions and pensioners' perks and ensuring that the forces fighting in Afghanistan receive improved operational pay and the equipment they need. All these exceptions will mean bigger cuts in other departments where some unpalatable decisions will have to be made. Likely cuts in university funding, for instance, will arouse protests not least when the country needs a well-educated workforce.

Taxes must rise, but incentives need to be preserved and the tax system has to be seen as reasonable and fair if tax evasion is to be limited. Again, difficult decisions will have to be made.

Severe cuts in public expenditure at this time are necessary, but when markets are depressed and economic growth has slowed, they run counter to Keynesian economic theories and could, as in Japan, lead to deflation. Keynesians argue that some inflation is better than deflation for national economies and can be useful in reducing the deficit in real terms. Britain, however, already has inflation higher than the 2 percent target set by the government and inflation rather than deflation is a more likely danger for the British economy.

Higher inflation could damage British competitiveness and those on fixed incomes. The British economy is not yet set on a steady path to growth.

Austerity measures are necessary for Britain and other European countries at present because of the limits to what we can borrow, but austerity measures are not a panacea and need to be applied in such a way that they encourage growth and employment and ensure that Britain remains competitive.

Japan, too, needs to get its finances in better order, but as Japanese people seem ready to go on lending to the Japanese government by buying government bonds, the Japanese problem is probably less immediate.

The U.S. deficit is the largest of all, but the dollar remains strong as countries with budget surpluses, such as China, continue to be willing to buy U.S. Treasuries, not least because there is no other world currency in which to place their cash.

Hugh Cortazzi, a former British career diplomat, served as ambassador to Japan from 1980 to 1984.


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