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Insights into UK manufacturing

The Budget must deliver deficit reduction and growth

Jeegar Kakkad June 21, 2010 08:54

Writing in today's Telegraph, EEF's Chief Executive Terry Scouler has called on the Chancellor to use his first Budget to make tough choices on deficit reduction, but also kick-start private sector investment in jobs, technology and growth.

Rather than rush for a draconian and unacheivable 80:20 split between spending cuts and tax rises, EEF believe that deficit reduction and growth can and should be complementary aims.

That's why we've been pushing for a 60:40 split, with a VAT rise minimising the need for savage cuts to captial spending and to capital allowances.

Capital spending is government funding of new roads, schools, hospitals and energy infrastructure - invest in any of these and you boost productivity and growth. Savage cuts to capital spending may be a politically easier target, but would inevitably fall most heavily on a small number of departments with responsibility for infrastructure and national security. This would have an immediate impact on businesses, including manufacturers, that count on Government as a major customer.

Capital allowances are how the tax system recognises the cost of investing in new machines and equipment. Cutting the level of capital allowances would make investing in the UK almost prohibitively expensive and force manufacturers to compete on labour cost, a battle they simply cannot win.

So we've opted for a 60:40 split with taxes on consumer spending (a VAT rise to 20%) to fill the hole in the public finances.

Unfortunately, the Chancellor appears wedded to higher spending cuts, as Stephanie Flanders blogged last week:

"Remember, too, that Mr Osborne and his advisers have always been much taken with the overwhelming historical evidence suggesting that raising taxes to cut large deficits can damage economic growth - whereas spending cuts do not. In fact, this same evidence suggests that cuts can even help, by supporting market and business confidence.

You may not endorse these arguments. There are those who say the research doesn't apply in this era of banking crisis and deeply fragile global demand. The point is that Mr Osborne does. And so does his team."

Like Osborne's advisors, we've done our homework too. But don't listen to us, just read a recent paper by Harvard economics professor Alberto Alesina on the right balance for fiscal adjustment:

"...evidence drawn from several episodes of fiscal adjustments in the late eighties and nineties (following the recessions and the large increase in public spending of the seventies and early eighties)...[shows ] spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns....In the case of successful fiscal adjustments about 70 per cent of it came from spending cuts and in the case of expansionary almost 60 per cent."

The chart below shows the results of Alesina's research. On balance, a 60:40 split is likely to deliver deficit reduction and growth.

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EEF helps manufacturing businesses evolve and compete.  We provide business services that make them more efficient and management intelligence that helps them plan.  Our work with government encourages policies that make it easy for them to operate, innovate and grow.

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