The great squeeze

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In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, turns his attention to what impact the coming fiscal squeeze will have on the UK economy. His main points are as follows:

• After a decade or more in which rapid increases in public spending have lent powerful support to the UK economy, the great squeeze is about to begin.
• The public finances are in the worst shape for at least half a century. Public borrowing is set to rise to around 15% of GDP this fiscal year, more than twice the levels seen when the UK was forced to seek the support of the IMF in the 1970s. Meanwhile, public debt is heading towards 100% of GDP.
• The Chancellor Alistair Darling put some measures in place to address the situation in April’s Budget. But they did not go nearly far enough. We estimate that a further fiscal tightening worth some 5% of GDP per annum – or around £70bn – will be needed over the next five years, and possibly much more.
• The bulk of this will come in the form of the tightest squeeze on public spending for a generation. Real spending may need to fall by an average of around 2% per annum for five years to deliver the required fiscal tightening. And given unavoidable increases in some spending areas like debt interest and social security, departmental budgets could see their biggest squeeze ever.
• Such cuts are likely to have profound effects on the economy. On its own, the impact on measured GDP of falling spending could knock over 1% off the annual rate of real economic growth compared to that seen in recent years.
• At the same time, though, deep cuts in public sector employment and wage growth will have significant adverse effects on the growth of household income and spending, as well as “multiplier” effects on activity and employment in some private sector industries.
• Overall, the spending squeeze could reduce annual real GDP growth by up to 2% compared to the rates seen during the spending splurge of the last decade.
• Some of this negative impact should be offset by the positive effects of extraordinarily loose monetary policy and a more competitive exchange rate. Nonetheless, rates of economic growth are likely to remain pretty sluggish while the squeeze takes place. And if the squeeze is too tight, the economy could fall back into recession.
• Who will be hit hardest by the great squeeze? The likely impact on employment and income suggests that consumer-related firms and industries will be amongst the heaviest sufferers. Meanwhile, the prospect of sharp cut-backs in public investment also bodes ill for the transport and construction sectors. By contrast, exporters should benefit from the lower pound.
• It’s not all bad news. The widespread consensus that drastic action is needed and justified to sort out the fiscal position presents the authorities with a once-in-a-generation opportunity to remodel the UK economy and to reduce its dependence on the state.
• Coupled with the lower exchange rate, that might ultimately pave the way for a period of better balanced, more sustainable economic expansion. But that prospect is still some way off. In the meantime, the great squeeze is going to hurt.

Notes for editors:

This press release has been prepared by Roger Bootle, Economic Adviser to Deloitte. If you have any questions regarding the views in it, please contact Roger Bootle directly on 07887 955 875 or 020 7823 5000 or via email on business@capitaleconomics.com.

This press release contains general information only and is not intended to be comprehensive nor to provide professional advice. It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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