A budget deficit in any country normally arises when government expenditure exceeds tax revenue thus placing a nation in a position where it needs to borrow in order to stay afloat. The UK is currently going through one of the worst budget deficits in history and in response to these patterns the government has come up with some detailed plans on what needs to be done in order to get the country back on its feet. These plans shall be scrutinised and possible effects on the economy will be suggested.
How the large budget deficit came about and the scale of the problem
In previous years, the UK enjoyed a very manageable national debt owing to a number of reasons; unemployment levels had been kept at a bare minimum and spending levels were reduced substantially. (Ferguson, 2008) However, in the past year the region has undergone a tumultuous phase in its financial sector (Office for national Statistics, 2010).
Clearly, having a large national debt has a number of repercussions on the region’s economy. First, the government will have to spend a lot on paying interest on debts. Those groups that lend to the government expect compensation for their actions through interest charges and this could exert a lot of pressure on the region’s stability. On top of this, a high budget deficit requires the government to mitigate their actions by selling bonds to members of the private sector. (Soros, 2009) On doing so, it is the private sector that feels the pressure because little is left to invest in it. In circumstances of high budget deficits, the government needs to borrow and in order to do that effectively, it must create conducive local environments for lenders since lenders tend to look for high interest rates. High rates for bonds can generally spill over into general interest rates thus affecting the economy negatively. People will cut down on investments and expenditures thus leading to lower economic growth rates. Another long term problem that is likely to surface in the wake of a high budget deficit is increased tax rates. In order to meet the costs of interest on government debt, future taxpayers will have to meet the costs of previous budget deficits. As if all the latter are not enough, there is staggering evidence to illustrate that the current deficit minimises the government’s options when it comes to fiscal policies. In order to boost aggregate demand it is necessary to increase one’s taxes. However, this can no longer be freely done because of the current financial situation in the region. (Krugman, 2009b)
How the government will bring down this deficit
The government through the Prime Minister asserted that it was planning on saving approximately three billion pounds over the next five years which is fifty percent of the current budget deficit. Top on this agenda is efficient utilisation of resources and introduction of new technology. (British Chamber of Commerce, 2010) The justification behind this approach is that technology improves quality of service delivery without necessarily increasing costs. In other words, efficiency is synonymous to savings made by government. Some of the areas identified in this plan include the education sector and health sectors where efficiency in student loan administration and health could result in savings of up to six hundred and sixty million pounds. A lot of wastage has gone in employment of advisory bodies for various sectors. Therefore, reduction of these bodies by about one hundred could result in savings that reach approximately half a million pounds. Waste procurement is also likely to create savings that reach the tune of five hundred and fifty million pounds. It should be noted that all the latter suggestions are geared at reducing government expenditure in the public sector. In line with the latter approach is the reduction in numbers of civil servants especially those who currently earn more than one hundred and fifty thousand pounds annually. Reductions of about twenty percent are likely to be witnessed during the coming five years. (Flanders, 2010)
It has also been asserted that tax increments are another strategy that will be employed to deal with this deficit problem. However, political reasons will affect the way either the conservative party or the labour party deals with the problem in the future. For instance, the Labour party has a high interest in developing the poor; therefore these changes are likely to target wealthy citizens.
Impact of the governments actions to reduce the deficit on the UK economy
Currently, the United Kingdom enjoys triple A rating which shows that the international arena has confidence in the region’s ability to manage its credit. In the current scenario, overseas groups that have invested in the UK need assurance on returns. This can be properly demonstrated through the prevalence of a workable plan to reduce the budget deficit. The actual existence of a government plan to handle the situation is likely to be taken positively by potential buyers of government bonds and this is likely to stir the UK’s economy in the right direction. (Blanchard, 2006)
As it has been seen before, the government is directing most of its attention towards reduction of expenditure. However, cost cutting cannot just be done haphazardly. History has shown that leaders must be very accurate on the right time to start i.e. when the economic recovery has just begun. If done too early, the UK will be thrown back into an economic recession. This is vey likely because in every country, there are always automatic stabilisers that contribute towards the reduction of a budget deficit. In fact the biggest headache for the elected government will be dealing with the structural deficit. The issue of timing can also present a serious problem in the next five years due to effects of inflation. Once monetary policies are changed too drastically, then chances are that prices of commodities will fluctuate.
In the coming five years, it is likely that tax increments will take on a marginal strategy by targeting high income groups. The major problem with such a strategy is that it may be a disincentive to potential businesses who may be interested in growing their investments within the region. (Krugman, 2009a) These marginalised taxes are also likely to have an effect on employment levels because high income earners will look for other ways of minimising their costs and this may be though reduced employment. Therefore a broad based approach to taxation increments would be more plausible. Also, the timing of such actions must be carefully done. It is likely that the increment of certain types of taxes such as the National Insurance Contributions could create a negative effect on the economy. There is a strong possibility that some of the businesses will be discouraged from continuing with their activities if they realise that they must meet tax increments through NIC. In the end, the government is likely to report greater unemployment levels and in the long tem, less revenue from taxation will be recorded. Therefore a better strategy would be increasing Value added tax on commodities. In this way, the government will have managed to promote recovery while at the same time generating more revenue.
So far, a lot of attention has been given to what the government can do to reduce the budget deficit. However, such analyses have not considered the fact that different players in the business arena have a large role to play in reducing the budget deficit as well. In the next five years, actions to mitigate excessive borrowing by the government could push employers to reduce wages. It can also cause the general public to pursue greater levels of savings. To this end, the recovery process will be drastically reduced. In order to minimise such a problem the government can borrow those savings and then spend them. (Blanchard, 2006) Interests can go up as a result of these actions and it would therefore be insightful if the government went to the root cause of excessive borrowing i.e. dealing with economic fundamentals in the region. (Haigh, 2009)
Comparisons with other countries of the world illustrate that Britain currently has a bloated public service. Some nations like Greece often replace one civil servant with every five that retire. Greece has been going through a series of economic challenges but its government has taken on a proactive approach to deal with the problem. Similarly, once the government cuts down on excessive salaries in the public service and once it reduces their positions to only a sizable number, then chances are that a lot of the financial difficulties prevalent in the region will be drastically reduced. It should be noted that the UK budget deficit plan is not the only thing on the agenda; recovery efforts are also a priority for the next five years. Consequently, a balance must be sought between these two important issues.
Most of the suggestions made by labour and conservative members have not mentioned wealth creation yet this problem has been an important determinant of the current budget deficit. The region is currently suffering from minimal injection of fresh capital especially in the housing sector. During 2003, the government opted to import capital through the international banking system. Now that the explosion (in housing) no longer exists, those resources have been redirected to other countries thus creating a gap in the region’s revenues. This process of churning wealth has created a vicious cycle where new avenues have not been sought. In the end, employment levels have been unreasonably high. The next government must assume a position of responsibility in terms of clearing this budget deficit. Absence of real wealth creation mechanisms could merely perpetuate current problems into future generations. (Krugman, 2009a)
Many labour government representatives have asserted that their most daunting task has been undoing fiscal decisions made in the Thatcher era. At that time, spending cuts were so intense that they eventually led to diminished economic growth witnessed subsequently. The UK has traditionally grown its economy through government expenditure. Therefore if current plans put forward by the latter body are anything to go by, then chances are that the economic recovery plan may be slowed down substantially. In fact effects of excessive spending cuts could be felt not just within this five year period but in generations to come. To this end, the government must try as much as possible to strike a balance in these spending cuts by not overdoing it.
Lastly, there can be no instant solutions to the current deficit. In fact, no single group will be spared from the harsh effects of these strategies. Marginalised groups or vulnerable citizens cannot be protected as doing so would require financial backup which is a huge problem now. Also, heavy taxation may cause would be investors to minimise expansionist strategies and this could slow down economic recovery. (Allsop, 2003) Bold steps need to be undertaken by the government as trying to please everyone in such a scenario will only cause more harm than good. The next five years could be promising if the government acts in a timely fashion and if it manages to strike a balance between spending reduction and economic growth. Also, the country needs to go back to Adam Smith principles that encourage creation of real wealth rather than taking chances on the financial and stock markets.
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Krugman P. (2009a). Revenge of the glut. New York Times, p 46
Krugman, P. (2009b). Return of economics depression. MA: Norton company
Soros, G. (2009). Worst market crisis in 60 years. Financial times London.
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Haigh, G. (2009). Stupid money. Griffith review, 25(5), 13
Flanders, S. (2010). Mr. Osbone’s prescription. Web.
British Chamber of Commerce (2010). Government must get a grip. Web.
Office for national Statistics (2010). UK economy [online]. Web.