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Tuesday, Dec. 6, 2011

Growth on austerity road

LONDON — The British chancellor of the Exchequer (the finance minister) in his autumn statement to the House of Commons on Nov. 29 admitted that the British budget deficit will last beyond 2015 — when a general election has to take place. That means continuing cuts in government expenditures and in public sector jobs.

Salaries in the public sector currently frozen will be allowed to increase by 1 percent in 2013 and 2014. As inflation has been running at 5 percent — although it is expected to fall to 2 percent from next year — the freeze and the cap on salaries means a real cut in earnings for workers in the public sector. They will also have to contribute more toward their pensions and have to work longer before they can retire.

Proposed changes in pensions resulted in a one-day protest strike Nov. 30. Discontent among teachers and other government employees is widespread and could lead to further disruption.

The chancellor argued that tough government austerity measures are essential if Britain is to avoid higher interest rates on what Britain borrows. So far, Britain has been able to fund its deficits at record low interest rates, and British debt has not been downgraded as has the debt of some eurozone countries and the United States.

The British economy, however, is faced with the prospect of minimal economic growth — 0.7 percent over the next year. Low growth and increased unemployment means less tax revenue and the need to pay out more in social security benefits for those out of work.

Inflationary increases in benefits must be met either by higher taxes or additional cuts in benefits enjoyed by those who work. The British economy is thus in a vicious spiral bringing a decline in standards of living.

The Labour Party opposition argues that to break out of this spiral, the country needs a Keynesian economic stimulus to be applied through limiting the planned cuts in government spending and by a cut in the value-added tax. They contend that the government's "savage" cuts have exacerbated the vicious spiral and dismiss the government's argument that a further increase in borrowing at this time would jeopardize current low interest rates.

While the chancellor rejected the opposition's call for a major economic stimulus, he nevertheless announced a number of measures which the government hopes will encourage investment and employment. These included government guarantees for some bank loans to small businesses, reform of some employment laws and of health and safety regulations, and limited help for first-time homebuyers.

In addition the government announced capital expenditure plans for infrastructure developments, especially in building roads. These expenditures would, the government hopes, be met by investment by pension funds and sovereign wealth funds. It remains to be seen how far these plans can be put into effect without increasing the public sector borrowing requirement and thus Britain's triple-A rating.

The government blames some of the problems facing the British economy on the crisis in eurozone economies, which are important export markets for Britain. The stalemate in the United States over budget cuts and taxes is another factor.

All in all, economic prospects are gloomy, but the situation facing Britain is not as bad as that in parts of Europe. Opposition to austerity measures in Britain is not as militant as it has been in Greece, and as it could become in Italy and perhaps other eurozone countries.

Greece has been living beyond its means for some years, and the Germans in particular are no longer willing to fund Greek profligacy and unwillingness to pay taxes. The Greek economy has been riddled by corruption and strangled by restrictive practices. The stronger Italian economy suffers from similar problems.

Spain has just elected a new center-right government and has passed a constitutional amendment forcing the government to take steps to balance the budget, but it has the highest unemployment rate in Europe with a particularly high rate of youth unemployment. It is also suffering from the bursting of a property bubble.

Ireland and Portugal have smaller economies, but both face the need for continuing austerity.

The euro's survival is no longer a certainty, but even the exit of one country such as Greece would be a serious blow to economic stability in Europe. Any state which decided to dispense with the euro and re-adopt its old currency would face huge problems. It is unlikely that banks in other countries would be willing to lend to it and the reintroduced currency would be immediately devalued. Import prices would soar, standards of living would plummet, and unrest would spread. Indeed, in such a situation, the country in question could become ungovernable.

The reluctance of German taxpayers to fund "profligate" nationals of states in southern Europe is understandable. If the eurozone were to break up and Germany were to reintroduce the mark, the currency would become the strongest in Europe. But this would seriously affect Germany's ability to export, thus delivering a bad hit to the German economy.

One of the greatest successes of the European Union has been the establishment of the single market. It is far from perfect, but it has led to significant increases in trade and in European standards of living. A breakup of the eurozone could have serious implications for the single market. European states whose economies would be seriously damaged might well press for protectionist measures. Countries outside the core could face runaway inflation.

Japan has faced years of economic stagnation and deflation. Europe could face an even worse situation unless European leaders and the International Monetary Fund move more quickly to tackle the current crisis of confidence.

Hugh Cortazzi served as Britain's ambassador to Japan from 1980 to 1984.

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