George Osborne's austerity dilemma is nothing new. Rewind 30 years and we were listening to the same old rhetoric. The then chancellor, Sir Geoffrey Howe, came to power with a burgeoning public deficit and, inevitably, he blamed the last government for his quandary.
Like Mr Osborne this year, Sir Geoffrey argued that past spending was based on incorrect and optimistic expectations. It's a "falsely reassuring belief", he crowed, "that somehow resources will be found to permit an expansion of public expenditure". The solution is to be "prudent and make deliberately cautious assumptions on growth", he said.
Mr Osborne also spent a large part of 2010 telling the country of his poisoned inheritance. "What we have not inherited is a credible plan to reduce the record deficit," he said at his emergency Budget in June.
And parallels between the chancellors don't stop at words. In the first four years of Margaret Thatcher's government, Sir Geoffrey almost halved the public sector borrowing requirement from 5 per cent of GDP to 2.7 per cent, which was a strikingly tighter stance than the other countries in Europe. Mr Osborne aims to go further, with the coalition looking to completely eliminate the budget deficit within four years by overhauling the welfare, tax and health systems.
On coming to power, Sir Geoffrey set about raising taxes, national insurance and duty on cigarettes and petrol. Like the coalition, he even placed a tax on bank profits. His austerity package caused unemployment to more than double from 1.2m to 3m by November 1983, while industrial output fell by a massive 11 per cent during the first parliament – making the first Thatcher government one of the 20th century's least popular.
"In retrospect, it was a determining step in gaining control of the public finances," then minister of transport, Norman Fowler, said of Howe's 1981 Budget in his political memoirs. "But that was not how it seemed when the cabinet were given the details a few hours before the statement."
David Cameron and his axe-men are taking a similar approach. Labour reckons the cuts are too much, too soon. The newly created Office for Budgetary Responsibility (OBR) recently revised down its medium-term forecasts for GDP growth for both 2011 and 2012. "Our central forecast is that the economy will continue to recover from the recession, but at a slower pace than in the recoveries of the 1980s and 1990s," the OBR said.
The independent forecaster also revised down estimates of public sector job losses from the 490,000 originally predicted, to 330,000. This means that the projected public sector employment losses are almost half those seen in the 1990s and a third of those seen in the 1980s under the Thatcher government.
Considering the coalition's squeeze on the public finances, Graeme Leach, chief economist at the Institute of Directors, finds the forecasts puzzling. "The peak-to-trough reduction in public spending in the 1990s was 7.4 per cent of GDP," he says. "The comparable reduction now is 7.9 per cent of GDP by 2015-16. So how can the employment shake-out be far less?"
The OBR said it changed its figures for employment losses after Chancellor Osborne's October spending review, where he shifted to cutting more money from welfare than local government. But, even so, annual cuts as severe as 7.1 per cent of departmental budgets were not seen under the Thatcher government. Back then, industry and housing suffered the most. "It was a different climate then," Mr Leach says. "You didn't have the talk of crunching cuts to department's budgets. So I think there are a lot of questions to be asked of the OBR's unemployment forecasts."
One area in which the government hopes it can cut costs but maintain jobs is procurement. Francis Maude has been talking tough with private sector companies and hopes to make the Whitehall machine more efficient. But the public spending squeeze could also be good for the market as a whole. Historically, there is a strong inverse correlation between PE ratios and government spending as a percentage of GDP, according to asset management house Schroders. Schroders' head of UK equities, Richard Buxton, says that when government spending decreases, the market re-rates. So while reduced spending could be unpopular with the electorate and the industrial unions, the government's austerity could actually be positive for equities next year.
