Macroeconomic Policies Undertaken by the British Government to Address the Budget Deficit
[Author’s note]
Introduction
According to HM Treasury (2010, p.7), the economic growth in the United Kingdom had been controlled by high private sector debts and an equally rising public sector debt. The wave of unbalanced growth and debt had brought about economic and fiscal challenges that the British government had to address (HM Treasury 2010, p.7). Elson (2012, p.177) opines that a budget deficit occurs when a government’s spending is more than its revenue. This scenario leads to an accumulation of both public and private sector debts. If the deficits are not controlled, they can cause high-interest payments and even lead to loss of confidence in any government (Pettinger, 2019). By 2008, the household saving rate had fallen, and its debt had risen to 100% of GDP because households borrowed heavily to consume the ever expensive property (HM Treasury 2010, p.7). Private companies took loans, reaching 110% of the GDP by 2008.
Additionally, the UK financial system had become one of the most leveraged globally, more than that in the US (HM Treasury 2010, p.8). With all the financial and economic adversities that were facing the UK, the government elected in 2010 used economic policies to reduce the then, so high, budget deficit. This essay, therefore, seeks to analyse the macroeconomic theories and economic policies that the British government used to reduce the budget deficit.
Macroeconomic strategies
HM Treasury (2010, p.11) opines that the provision of the right macroeconomic conditions would help correct the imbalance between the public and private sectors in the United Kingdom. The right environment would underpin a sustainable recovery that is more balanced across all areas of the economy. The then prevailing high public borrowing undermined fairness, growth, and economic stability in the United Kingdom. HM Treasury (2010, p.11) presented that borrowing was to be brought under control and public debt as a proportion of the GDP was to be placed on a downward path. Reduction of public sector borrowing would instill confidence in the private sector and reduce competition for resources for private sector investment, boost growth and job creation (Saunaris and Pyne 2010, p.481)
Reduced government expenditure
Budget deficit is when the government’s expenditure exceeds what it gains as revenues. Therefore, one of the macroeconomic policies that the government can use to attain a balanced budget is the reduction in its expenses (Krogstrup and Wyplosz 2010, p. 270). The government can cut its public spending to reduce its fiscal deficit. In the Eurozone crisis, several countries cut government spending in an effort to reduce their budget deficits. From 2010 to 2015, Greece, Spain, and Ireland all cut their government expenditure, though the reduction contributed to a decline in economic growth (Valiante 2011). For this macroeconomic policy to be effective, it depends on the type of government spending that is cut. If a government cuts pension, then there may be an increased production capacity. If the public investment is cut, then there will be a more significant negative effect on the demand and supply side of the economy. It is, therefore, more tempting for the government to cut benefits and pension as this reduces expenditure with minimal impact on economic growth (Pettinger, 2019). According to HM Treasury (2010, p.16), the British government identified £6.2 billion of saving in 2010-2011 and called off nearly £2 billion of its projects that had been approved since January 2010. HM Treasury (2010, p.42) further opines that “Efficiency and Reform Group” was set up to ensure immediate freezing on unnecessary spending on consultancy, advertising, and ICT. Two-year freezing was also introduced for the public sector workforce that was to save £3.3 billion annually by 2014-2015 (Parry 2011, p.5).
Increased Taxes
Rausch (2012) presents that higher taxes increase government revenue and help to minimize the budget deficit. The government runs on a surplus when it spends fewer funds than what it earns through taxes and operates on a deficit when it spends more than what it gains in taxes (Ross, 2019). In the early 20th century, economists and advisers embraced balanced budgets or budget surpluses, but with the development of Keynesian economists and the rise of demand-driven macroeconomics, it was politically feasible for states to spend more than what was gained. Increment in government taxes is a contractionary fiscal policy that leads to an increase in surpluses in the budget. However, like reduced government expenditure, tax increases can lead to lower spending and a fall in economic growth. Therefore, it depends on the timing of the tax increase. In the case of depression, a tax increase causes a decline in spending while during high growth, an increase in tax may not harm spending as much. The type of tax increased also matters (Denes et al. 2013, p.135). The British government made a decision that the standard level of VAT was to be increased from 17.5% to 20% as well as rates under small businesses (HM Treasury 2010, p.51). Excise duties on alcohol and cigarette was also increased by the government as well as the national lottery taxation. Tax compliance in the UK was also boosted as the legislation was introduced to prevent tax avoidance. Taxes on stamp duty, EU emission trading system, landfill tax as well as company tax was increased to maximize the amount of revenue that the UK government could get (Smith et al, 2016).
Economic Growth
One of the best ways to reduce a budget deficit as a proportion of the Gross Domestic Product is to enhance economic growth (Saleh and Harvie 2005, p.211). If the economy grows, then the state will increase tax gains without necessarily raising taxes. With economic growth, the population pays more tax; companies pay more corporate tax, and employees pay more income tax. Pettinger (2019) alludes that high economic growth is the least harmful method to reduce a budget deficit because the government does not need to raise tax rates or cut spending. To do this, two schools of thought are considered:
Keynesian Approach
The Keynesian economists believed that a government could enhance economic growth through its spending power to create demand and stimulate the economy (Lavore, 2014). The idea of deficit spending as an economic stimulus is attributed to John Maynard Keynes, who argued that during recession or a depression, a fall in consumer spending could be corrected by an increase in government spending. According to Keynes, maintaining demand was critical to avoiding a period of high unemployment that could lead to an increased budget deficit through private sector debts. Keynes centered his argument, stating that the markets are imperfect and will not always self-correct. Inefficiencies caused naturally will see some goods not met with demand. This form of inefficiency wastes capital, which results in market loss and unemployment. Keynes opined that markets needed a government intervention through fiscal policy, where the government invested in infrastructure as well as the use of monetary policies. On employment, Keynes argues that communities are resistant to wage reduction and that the decline in wages would pose a severe threat to the economy. Reduction in wages reduces the spending ability of the people, which results in a downward trend in the economy.
Furthermore, Keynes noted that too much saving is also a threat and cause of an economic downfall. Excessive savings leads to reduced investment and reduced expenditure, which lowers demand and the ability to consume. The British government, therefore, identified the £6.2 billion of savings in 2010-2011 and decided to invest in government projects as a way of increasing investments to reduce the budget deficit (HM Treasury 2010, p 16). As an economic growth theory, Keynes believed that when a government spends £1, this could increase total economic out by more than the £1 invested by the government. This factor is what he comes to call the “multiplier effect” (Ono 2011, p.787)
Classical Approach
The basic principle of the classical theory is that the economy is self-adjusting. Classical economists insist that the economy is capable of achieving the natural level of output that is derived when the economy’s resources are at full employment (Meade, 2013). Self-adjustment policies exist within the market system that work to bring the economy back to the natural level of output. The classical doctrine is that the economy is always near the natural level of real GDP. According to the classical growth theory, economic growth will decrease as a result of increasing population and scarcity in resources. Under the classical approach, unemployment is often attributed to high real wages. Classical economists believed that unemployment that occurs in an economy or a resource market should be considered as “voluntary unemployment”. It is voluntary in that workers are unemployed because they refuse to take the minimum wage, if they were willing to accept the minimum wages, firms would be willing to employ them. Classical economists developed an idea of a “Subsistence level” where subsistence referred to the minimal amount of income needed to survive. Income beyond these levels, translated to profits. The British government lowered the wages of the employees to the lowest level, where the firms were willing to employ more of the workers. This was a policy used by the government to get the economy back to its natural state of unemployment.
Interest Rate Manipulation
Keeping interest rates at low levels is a process used by the government to stimulate the economy, generate tax revenue, and in the long run, reduce the national debt. Low-interest rates encourage individuals and businesses to borrow money. Those borrowing money, in turn, spend it on goods and services, which creates a demand-side push on the economy whereby employment is created, and there is an increased tax revenue collected by the government. The United Kingdom, in 2010, reduced the interest taxes, which proved some degree of success. According to HM Treasury (2010, p.81), the interest rates were 5.75 in July 2007 but had fallen to 0.5% by March 2009. The government further lowered the rates to 0.25% in 2016.
Conclusion
During the 2008 economic recession, many countries across Europe were faced with financial and economic problems that were to be addressed immediately. Britain was among the worst-hit state with this economic recession. Therefore the government that had been elected in May 2010 had to use appropriate economic policies to reduce one of the financial problems, a budget deficit. As presented in the paper, the UK government undertook measures to balance the budget through macroeconomic policies that reduced spending, where government projects worth £2 billion were canceled. An increase in taxes was also employed by the British government to increase revenue. A stimulus expenditure was also put in place to facilitate a growth in the economy as well as reduced interest rates in the banks. The essay, therefore, concludes that the approaches by the British government were appropriate economic policies that are similar to the macroeconomic theory.