SPENDING REVIEW

The Chancellor, George Osborne, is determined to stick to his guns, with yet another £11.5 billion of budget cuts to be delivered in an election year. Some may say this is a massive gamble for a Conservative Chancellor who will wish to see his party elected at the next general election.

But the Chancellor has to retain the confidence of the financial markets by showing he is willing to tackle the legacy of deficit and vast levels of debt left by Labour.

If the markets no longer have confidence in the economy, Britain’s low interest rates, which are so vital a component to recovery and growth, will come to a shuddering-halt. If that was to happen, many would face financial disaster.

The first fruits of Mr Osborne’s determined approach is seen in the latest publication from the Office of National Statistics which has presented its revisions of gross domestic product (GDP), the key measure of the total output of the economy.

After a dreadful couple of years, the economy appears to be genuinely on the mend. In the first three months of this year it recovered healthily, despite some poor weather which usually slows down performance, but this trend is confirmed by all the major economic indicators and surveys.

The influential National Institute of Economic and Social Research, an often stringent critic of the government, says that output expanded by 0.6 per cent in the last three full calendar months.

This means that the ‘modest recovery’, often referred to by the retiring Bank of England Governor Mervyn King, is well and truly underway.

Earlier estimates of GDP underplayed the actual health of the economy. Early estimates of construction activity, for example, fell short of the true picture. Building programmes ranging from shopping centres in Leeds, to new office towers in the City of London, as well as new homes being built across the land is evidence of that.

The building industry certainly looks to be doing much better than was previously thought. It is this improvement – together with a formidable robust service sector, sharply better production from the North Sea, and higher export levels (especially to America) – that is turning the economy round.

According to fund managers Henderson of the City of London there has been a strong pick-up in the amount of money circulating in the economy. They suggest that, on current trends, the UK could be among the fastest-growing leading Western nations this year, expanding by a remarkable 2 per cent.

In his House of Commons address, Mr Osborne hinted at the underlying strength of the economy. He pointed out that for every one public sector job that has been lost as a result of austerity and cost cutting, another five have been created in the private sector.

Essential to the delivery of continuing growth, however, will be the discovery of new markets for Britain’s goods and services – not least because of the appalling health of the economies of our major trading partners in the European Union.

The Chancellor said that one of the keys to this will be a ‘strengthening of trade and investment links with China’. As a spending priority, the Government is planning to work with Britain’s exporters to set up a series of centres to promote British goods and services in China’s fastest-growing cities. Switching the focus from Europe to the new wealth-creating economies of Asia is going to be critical for our continuing recovery.

In the meantime, however, it is Britain’s close trading and financial relationship with the United States and its recovering economy that is proving most important to export-led growth. Exports of both goods and services to the U.S. have been climbing strongly in recent months.

Amid the intense interest with what is going on in Brussels and the eurozone, it is often forgotten that America is by far our most important single marketplace. The UK exports to the U.S. everything from Rolls-Royce engines to defence equipment as well as music made by British iconic figures in our pop industry.

No one, though, should underestimate the task of what the government is faced with in building up the economy to the peak it reached before the 2008 financial crisis.

The UK’s debt is continuing to climb despite the cuts and will not reach its height until 2016, when it will be the equivalent of an alarming 93.2 per cent of the nation’s output according to the latest IMF forecast.

If items such as public sector pension liabilities, which are hidden from the country’s balance sheet, are included, our debts will actually exceed national output in 2016. The Chancellor’s latest reductions in spending, in fact, represent less than 0.1 per cent of the national debt as projected in the year 2015-16.

The Chancellor’s trimming of the national budget, despite the hysteria of hard-hitting cuts, is no more than a holding operation designed to stabilise market confidence between now and the election.

The arrival nest week of the new Bank of England Governor, Mark Carney, poached from the Bank of Canada, has the task of not just keeping inflation close to the Government’s 2 per cent target but also to support growth.

Now that the housing market finally appears to be recovering from the shock of the financial crisis, and more small and medium-sized businesses are taking out bank loans to expand, any increase in interest rates by Mr Carney would be the last thing the Treasury needs. Mr Carney will chair his first meeting of the interest-rate-setting Monetary Policy Committee next week and will set in place the new mandate for the Bank of England as outlined in the budget.

Mervyn King has warned of the dangers this would pose in terms of homeowners struggling to pay mortgages and the loss of confidence in business circles.

The financial markets, it should be remembered, are still extremely jittery. The mere suggestion last week that the United States might curb its huge amounts of quantitative easing (Q.E.) – or printing money – sent share prices crashing across the globe. Mr Carney will want to prevent that happening at all costs, as will the Chancellor.

State spending reductions, while necessary and essential to calm the markets, can only make a small dent in Britain’s deficit and debt. It is higher-than-expected growth that could radically alter the picture.

The greater the output of the economy, the more taxes are paid – and the less money is paid out in welfare benefits because so many more people are employed.

If Mr Osborne can deliver sustained growth by the election, he would then be in a strong position to be even more radical, by taking a long-overdue axe to Britain’s mammoth social security bill – by removing, for example, many generous benefits to wealthy pensioners – and put the economy on a path to true prosperity.