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Saturday, Dec. 11, 2010
Will U.K. cuts keep economy afloat?
Japan's past spurs debate over austerity measures for recovering industrialized economies
Britain's plans to reduce its ballooned fiscal deficits through massive government spending cuts received mixed reviews from the country's veteran journalists during a recent symposium in Tokyo.
Does the experience of Japan — which suffered nearly two decades of economic doldrums following the collapse of its bubble boom in the early 1990s — serve as a lesson for the U.K. government to act quickly to reduce public debts? Or does Japan's prolonged economic woes point to the risk of Britain taking radical austerity steps too soon after a crisis?
These were among the questions pondered by journalists from major British media organizations who took part in the Nov. 19 symposium organized by the Keizai Koho Center, discussing the common challenge confronting industrialized economies — putting their economies back to fiscal health without harming the fragile recovery. Akira Kojima, senior research fellow of the Japan Center for Economic Research, served as moderator of discussions.
In October, the Conservative-Liberal Democrat coalition announced the biggest government spending cuts in decades, which would shave £81 billion ($130 billion) through 2015 and slash nearly half a million public-sector jobs. It is an attempt by the government of Prime Minister David Cameron, who took power after the May general election, to cut the budget deficit that had swollen to one of the highest levels in the industrialized world after the previous Labour administration undertook huge stimulus measures in response to the 2008 financial crisis.
"Should the government move quickly to reduce its deficit to convince financial markets of Britain's creditworthiness? Or is it a big mistake to be cutting the deficits so quickly, given the fragile state of the economy in the U.K. and other leading economies?" said Hugh Pym, chief economics correspondent of the BBC. "It's a very big political debate" in Britain as "many eyes in other countries are on the U.K. to see if its ambitious program of deficit reduction is going to be successful."
Britain's budget deficit relative to gross domestic product, Pym said, has arguably reached an unsustainable level — behind only Ireland and Spain in the International Monetary Fund's forecast for 2011.
The country's outstanding public-debt-to-GDP ratio — just under 90 percent — is still below its long-run average and far lower than the rate in Japan, which by different definitions varies from 150 percent to 200 percent, he said. Still, some say the sharp rise during the latest recession can be evidence of potential big problems ahead, and research shows that when the debt-to-GDP ratio climbs above 90 percent, the debt starts to suppress economic activity and thus slow down growth, he noted.
On the other hand, a look at Britain's past recessions shows that the latest one is a relatively deep recession, from which the economy normally takes a long period to get back to its peak level of output, Pym said. The long-term trend of economic performance by nations that experienced recessions after financial crises, including Japan, shows that those countries take a long time to return to their previous level of economic activity — which may support the view of people who warn cutting the government borrowing now is too risky, he said.
Britain also faces the severe challenge of deleveraging in the household sector — where the level of liabilities relative to disposable income is higher than in any other industrialized country, he said.
"The U.K. came out of the financial crisis with too much debt on both the private and public side," but "such problems are not new here in Japan," said Jonathan Ford, chief editorial writer and associate editor of the Financial Times.
A decade ago, discussions on the Japanese economy focused on how the private sector was repaying its borrowings and government debt was rapidly rising.
"A decade later, things have clearly moved on and deleveraging is less of an issue now. But overall, the themes have remained uncannily similar," Ford said.
"The emphasis remains on the intractability of Japan's high national debt, the problem of chronic deflation. People remain uncertain about the future, and worried no solution to the country's economic problems have been found," he said. "There is widespread skepticism about the ability of politicians to restore the economy (to a healthier state). These problems can last for a long time, and they can be very difficult to resolve."
In the late 1990s, there was a sense that Japan's economic ailment was a special case, he said. "Now there's evidence that Japan is not unique, but may just be ahead of its time in its manifestation of symptoms" that are common among industrialized economies, he added.
"Japan is wrestling with a huge problem that will ultimately be shared by most, if not all, of the large advanced economies," he said. The lack of affordability of social security for the postwar baby-boom generation — now reaching the retirement age — is a challenge the U.S., and Britain and other European economies all face, he added.
"This problem was always likely to lead to a crisis at some point, but the credit crunch (in recent years) has accelerated it by weakening the balance sheets of the advanced economies," he said. "Not only does the cost of welfare in an aging society place an enormous burden on the public finances. It also causes significant shifts in the economy in consumption patterns."
Dealing with these issues will require political leaders to make hard choices, and while it's tempting to wait to make the difficult decisions, it's always not a good strategy, he said. "Holding off on social security reform is not a good idea if you're in a rapidly aging society. If you leave it for too long, you will find that retirees and near-retired are most reluctant to surrender the very significant societal advantages they enjoy," Ford said. "It is more likely that the problem will only be resolved in the peak of a major crisis after a prolonged period of economic strains."
The U.K. government's strategy to rapidly consolidate its fiscal position, Ford said, is indeed risky but necessary.
"The crisis struck when the private sector built up an unsustainable level of debt and needed to start paying it down and restore itself to solvency. To ease this rebalancing, the U.K. government needs to keep interest rates low and provide liquidity to its banks," he said. "At the same time, the public debts have been rising sharply because of the falloff in economic activity due to the crisis, and this has reduced tax revenues and led to very large public deficits."
The current plan would see the structural deficit eliminated over the next five years — with public spending cuts set to account for four-fifth of the consolidation, he noted.
There have been objections that the strategy ignores the fragile conditions of the country's economic recovery, Ford said. Some also argue that the U.K. debt situation is different from Greece or Ireland in that its government bonds are mainly purchased by domestic investors and are not as internationally exposed as other European economies hit by the sovereign debt problem, he said.
"But I would still argue that the U.K. government is right to attempt to deal with the deficit now, rather than put things off" — mainly for political reasons, he said.
There is a broad consensus that Britain's public debts are too high and must go down, with the question mostly on the timing and the scale of cuts, Ford said. What is also clear, he added, is that fiscal consolidation of any scale is politically very difficult.
"Governments don't make themselves popular by cutting public spending, so they generally only do it when they believe they can do so without destroying their own career," he said. "The formation of a new coalition government in the U.K. in May created a window for debt reduction. It was imperative from a political perspective to strike right at the beginning of the government's five-year term of office.
"It seems to me unwise to put things off" in the hope that there will be better opportunities in the future, he said. "Japan has been waiting for two decades and the choices only seem to get harder and harder with each passing year."
On the other hand, Aditya Chakrabortty, an economics editorial writer for the Guardian, called the U.K. coalition's debt-reduction plans a "triumph for politics and a disaster for economic good sense." The debate over the fiscal policy in the country is "a prime example of leadership being allowed too much headroom while important and vital argument is ignored," he said.
"The spending cuts are economically damaging, unfair and deeply divisive," Chakrabortty said. The result will mean a large number of people losing jobs and "some poorest members of the British society will have their social security cut while some of the richest will barely notice this new era of austerity."
Britain's public debt is roughly less than half of Japan's, and the country's public finances were among the soundest among the G7 economies — up to the collapse of Lehman Brothers in 2008, he said. Borrowing rose sharply since 2008, but that is solely the consequence of the economic crisis, he added.
The coalition, Chakrabortty said, is also on the wrong side in its economic assessment.
"The U.K.'s sluggish economy is in the middle of Europe, the sluggish region," which does not have China, which has kept Asia out of recession, and Britain exports 10 times as much to Ireland than it does to China, he said.
"We had a few months of strong growth — but almost no one expects that to continue until next summer," he said. Britain's exports are not seeing any boom despite the weakness of the pound, and surveys point to consumers' sentiments turning increasingly pessimistic about jobs and a double-dip recession — obviously not a condition where business investments would be expanding rapidly, he noted.
"But the Conservatives won the argument that the state is too big and so must be trimmed back," he said. What is depressing about the fiscal policy debate, he added, is that it is "confused."
The debate around fiscal consolidation can be split into several discrete questions, he said. Should the U.K. start the austerity now given the bleak domestic and international economic outlook? Should it try to do it mostly through spending cuts or through balanced tax increases and spending cuts? Or how much should the nation worry about the social impacts of the cuts? Does Britain need a smaller state?
"It's possible to think we shouldn't attempt to start it now, but we do need a smaller state in the long run. It's also possible to think that we should have austerity but more fairly," he said. "For political purposes, and in the interest of leadership and direction, all questions have been muddied into one."
The Daily Telegraph's City Editor Richard Fletcher said the first postwar coalition government that emerged out of the indecisive general election in May appears to have helped, rather than hindered, the British attempts to reduce structural fiscal deficits.
But the honeymoon is certainly over now, and the British economy and the coalition government face severe tests in the coming months, Fletcher said.
Before the election, financial markets and the public appeared to be spooked by the prospect of the first hung Parliament in decades, with the concern that a weak administration would lack the mandate or the political will to make necessary cuts to reduce the budget deficit, he said.
Several months after the launch of the coalition government, "the markets certainly seem to have at least some faith in (the coalition's) ability to deliver," he noted.
Fletcher added: "Public support is widely acknowledged as a key component of a successful fiscal consolidation. The public has to believe that the cuts are fair and sensibly balanced."
Recent U.K. economic statistics have been more upbeat, which dampened talk of a double-dip recession, but even the most optimistic forecasts project a sluggish recovery of GDP growth below 2 percent this year and next, Fletcher said.
"The strength of the economy and the coalition government will face a severe test in the coming months. The value-added tax will rise to 20 percent on Jan. 1, government spending cuts will begin — an effective pay cut for the millions," he said.
It is forecast that consumer spending will stagnate in 2011, he added.
"Deficit reduction and ensuring economic recovery was the first item on the first page of the coalition agreement published days after the general election," Fletcher said. "Ultimately, the success or otherwise of this very un-British coalition will be judged on whether they've delivered that."