In fact, analysis by the Social Market Foundation and the Royal Society of Arts suggests that to get the debt reduction plan back on track, the government will need to introduce a package of tax increases and/or spending cuts of £48bn at the next spending review. That’s considerably more than we spend on the three armed forces, and it’s also clearly unachievable unless the government entertains the idea of a radical remodelling of public service provision. It could be argued that the whole process has been allowed to slip, meaning that more radical steps are now required. In 2010 for example, the spending review sort to wrap up the deficit reduction programme by 2014, but then in March this year the suggestion was that another £26bn would have to be found to bridge the gap. Unfortunately, since then the economy slid back into recession, so now another £22bn needs to be found to see the job done by 2018. So if we rule out tampering with current spending priorities it implies that departmental spending would have to be cut by 23 per cent.
Part of the problem here is that borrowing projections as a percentage of income have been thrown into disarray because the economy’s ability to bounce back from recession is now significantly less than assumed at the time of the March budget this year. True, third-quarter GDP came back with a bounce, but this level of growth is expected to fall back in the fourth quarter. More worryingly, the output gap between the economy’s performance and its potential is likely to have narrowed from 2.7 per cent to 1.8 per cent, which suggests that there is a third less room for the economy to bounce back.
Of course, these numbers could all change, as indeed they already have. And faced with the unrealistic prospect of shrinking some government departments drastically, the only answer is to stimulate growth. There are arguments suggesting that some of the muscle as well as all of the fat have already being cut away, thus affecting the ability of the economy to recover. And Mr Osborne has the task of trying to stimulate growth without giving the impression of easing up on deficit reduction. But credit markets are not renowned for going easy on any government that preaches fiscal laxity, and that means Mr Osborne is currently stuck between a rock and a hard place. It is hard to see how he will be able to close the funding gap without formulating a meaningful and credible package to stimulate growth.
Chris Dillow will return week beginning 26 November 2012.
