The new government's public spending dilemma | KPMG | UK

The new government's public spending dilemma

The new government's public spending dilemma

Does UK election result spell the end to austerity?

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KPMG in the UK

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If the election result proved disappointing for the returning Conservative government, amidst the many issues that swayed voters, two are critical for the economy: the type of Brexit the UK should seek to negotiate and public weariness with austerity. While all eyes are likely to turn to the start of the exit negotiations, the new government would ignore at its peril the clear message it received from voters on one of the key domestic issues. So is the end of austerity in sight?

UK public finances have gradually improved since the Great Recession; public sector deficit fell to £48.7 billion (the figure represents public sector net borrowing excluding public sector banks) in the financial year to March 2017, according to the latest estimates by the ONS, representing 2.5% of GDP, compared to a deficit of nearly 10% in 2009-10. However, weaker growth meant that inroads into reducing overall debt have been less successful, with public sector debt standing at just over £1.7 trillion at the end of April 2017. That amounts to 86% of UK GDP, far higher than the rates of below 40% the country enjoyed prior to 2008-9. 

Expected headwinds ahead will put renewed pressure on public finances. A slowing economy, a potential hefty exit payment to the EU, and an eventual gradual rise in borrowing costs are all coming our way. They leave the chancellor with scant room for manoeuvre if things go wrong and the economy will need a substantial boost to get it out of a rut.

The new government will need to carefully assess its new spending commitments, including pledges to its new DUP partners and possible implications for spending elsewhere in the UK, to ensure it makes the most of the little it has.

Increased public spending may be the right course for the UK economy at this juncture, particularly if that spending is used to boost UK’s poor productivity performance, helping the economy grow faster and thus lowering the debt burden thanks to the larger size of the economy. Areas on which the government could focus include improving regional transport and telecoms infrastructure, as well as more investment in skills and education.

The current public mood probably hankers for something more, but there are no free lunches – and ultimately someone needs to pay. In order to further ease austerity, the new government will either need to raise taxes, making at least part of today’s tax payers fund the increased spending on areas such as health and public sector pay, or opt to fund higher spending by increasing its borrowing, effectively making future tax payers pay for our generation today.
 

Macroeconomic blog

Macroeconomic blog

The latest thoughts from Yael Selfin, Chief Economist at KPMG in the UK

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