George Osborne's Big Bang Budget yesterday, in which he announced some seriously painful public spending cuts and tax hikes (20% VAT being the highest-profile example), has inevitably sparked some strong reaction. But it was interesting that the Office of Budget Responsiblity reckons this unprecedented fiscal tightening will only trim output by about 0.3% this year. With the public sector set for major cut-backs, it's presumably working on the assumption that the private sector can step up and fill the gap. But is it in any state to do so?
Some of the measures announced yesterday will help, of course. For a start, the Chancellor seems keen to move to a system of lower, simpler corporate taxes. So as well as the drop in the corporation tax rate (for large and small companies), he also talked about the need for clarity and certainty, promising to consult business about creating a more stable regime. This will encourage firms to invest, without worrying that there could be some nasty surprises around the corner. Equally, the tough action on the deficit will probably help keep interest rates down for the time being; again, this will encourage business to borrow.
Nonetheless, the question remains: will the extent of this axe-wielding suck too much demand out of the economy? We can't help feeling the row over the VAT hike is a bit overblown, since a) it doesn't apply to essential items, b) some retailers will just suck it up anyway, and c) the price difference may not be sufficient to put people off buying stuff (or so recent evidence suggests). But in the round, with other taxes also going up, benefits coming down and a likely surge in unemployment thanks to the cuts in the public sector, it's not exactly hard to imagine a drop in demand for goods and services.
To some extent the public sector is just being forced to do what the private sector has been doing for the last two years: cutting costs and delivering more for less. But we're still talking about cuts on an unprecedented scale here (the full horror won't be evident until the spending review - we've only had 20% of the detail so far). And unless some of these soon-to-be-ex-civil servants can be fairly rapidly redeployed in the private sector, it's going to be bad news for the recovery.
Fortunately, there is some cause for optimism on that front: Brian Wilkinson, the UK boss of recruitment firm Randstad, argues that the service-based nature of the UK economy and the sophistication of recruitment processes mean it's much easier for staff to switch sectors than ever before. Then again, that assumes companies are willing to hire. And despite yesterday's sweeteners, the outlook is still pretty dubious for many.
Quite apart from UK demand issues, many of our biggest export markets are also on their knees. What's more, many firms are still struggling to obtain bank finance at reasonable rates. Perhaps more than anything else, the Government needs to resolve this thorny issue - because without lending to support investment, there's no chance of the private sector picking up the slack and driving the recovery.
In the longer term, it seems logical that rolling back the state should help the private sector to flourish. But whether it can bounce back as quickly as the Government and the OBR seem to think, only time will tell. Until then, everything is just guesswork.
In today's bulletin:Budget 2010: Can the private sector pick up the slack?
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