Embracing a New World

As Europe readies for deep financial cuts, the international community must also prepare

Western governments simply cannot spend as they did before. For the first time they are having to prepare their populations for major cuts, which will have an impact on health care, education, social services and welfare spending

By KERRY BROWN

People have been talking in Europe of an age of austerity since the end of 2008. The expectation of large cuts to government spending has been widespread. The question was just when the cuts would start. Recently, the UK,German and French governments have all made clear that the cuts must start now. And all of the governments of the main economies in the EU have started spelling out what has to be cut back, what it will mean for people, and how much has to be saved.

According to a Financial Times opinion poll on July 12, more than two thirds of people in the EU support cuts, and would like to see them sooner rather than later. They also oppose tax hikes. In a choice between government reducing its expenditures and people paying more through personal or company taxation, the preference is clear. Populations don’t trust their governments to spend their money wisely, and think that they have grown too big, employ too many people and are active in too many areas.A similar survey in the UK alone at the end of June showed that the majority of people don’t think that government cuts will affect them anyway.

Now that the axe has started to fall on government expenditure, we have to ask a number of questions. The first is simply whether it will have the desired effect of returning major economies to healthy growth in the span of a few years. The second is whether it will start causing social unrest and opposition in some countries.And the third is how it will impact the global political and economic situation.

Controversial cuts

There is, in fact, no real consensus, among either politicians or economists in the West,as to whether dramatic, deep cuts will actually work. The Labor government under Gordon Brown held the belief, before it was voted out of power in May of this year, that too many cuts too soon would create a double-dip recession, causing huge rises in unemployment, and return the UK to the same negative growth it experienced in 2009. For the new coalition government, led by the Conservatives, the view is that the UK cannot continue to service interest payments on government debt that is 12 percent larger than government receipts. This is one of the largest deficits in the developed world. Overall, government debt in the UK stands at almost $900 billion. The fear is that in servicing this debt, most government income will be spent on interest payments. This was the motivating factor behind the emergency budget announced in late June which suggests up to 20 percent cuts in some areas of expenditure.

U.S. President Barack Obama has made it clear that he does not see these kinds of cuts as bene ficial. He and his policy advisors stick to maintaining government spending,so that the economy is stable and supported.Their priority is to address the lack of jobs in the United States, where 10 percent of the population is unemployed. But the UK can argue that the situations in the two countries are not exactly the same. Growth in the United States is likely to be higher than in the UK this year. It is a much larger economy,and has a much greater manufacturing capacity. The fundamentals for the United States,as some would say, look markedly better than for the UK. Obama made clear at the Group of 20 meeting in Toronto, Canada, in late June that he understood the moves made by the new British Government. And in any case, the previously mentioned Financial Times survey showed that popular support for cuts in the United States was almost as high as in Europe.

For Germany, things are slightly different. It is a major exporter, sitting just behind China. It has a massive manufacturing base,and although unemployment is high, it has started to enjoy reasonable growth rates again. The euro zone economic crisis caused by spiraling debt in Greece over the spring and summer only showed how powerful Germany now is in Europe. It got most of the conditions it wanted when the fi nal bailout deal was agreed. Even so, Chancellor Angela Merkel and her coalition have also announced sweeping cuts, creating anger in some other European governments because they regard these as being too severe, unnecessary and likely to create problems in other markets outside of Germany. Germany doesn’t have to deal with a de fi cit anything close to the size of the UK’s. But it does worry about the drain on its economy, if the euro continues to depreciate. And it has a hugely generous social welfare system which now no longer looks affordable.

France, too, is starting to face cuts, despite the strength of its unions and threats of strikes.President Nicolas Sarkozy is entering one of the most dif fi cult periods during his time in power,with falling popularity ratings, a looming election in two years’ time, and huge challenges about how to scale down public expenditure in a country where opposition to such cuts has usually been very strong.

Social implications

It is clear that a major rebalancing of the EU economy is underway. This is reaching into the whole developed world. Western governments simply cannot spend as they did before. For the first time they are having to prepare their populations for major cuts, which will have an impact on health care, education, social services and welfare spending. The political and social outcomes of these could be very rough. The UK has looked at the huge cuts Canada made in the 1990s to reduce its de fi cit. There, social unrest was avoided. But much of the current government’s strategy is based on trying to do things in a different, more ef fi cient way,without fundamentally changing what is provided. They talk of cutting back waste,middle-level management, and duplication and bureaucracy. Faced with the need to save billions of pounds over five years, however, it is hard to see how all of this money is going to come from one source. The bottom line is that some services will be cut, and that will impact society.

For all the talk of ef fi ciency being the keyto delivering cuts, the vast bulk of UK government spending goes not to defense, or education or running courts, but to welfare and health spending. These alone take up over one third of all UK government expenditure. It would be a similar figure across the EU. And these are the budget areas where politicians, in the end,have to direct their most sustained attack. No one underestimates the problems this will cause.Both of these areas affect people directly. They impact, for instance, how much people get in allowances if they cannot work or when they are retired, or the kinds of treatment they can get in hospitals.

EMPLOYMENT UP SLIGHTLY: British commuters head home in London on July 14. The UK Office for National Statistics reported the UK’s unemployment rate from February to May dropped to 7.8 percent, a 0.1-percentage-point decrease over the previous quarter

One immediate target has been pensions.Both in France and in the UK, the retirement age is now being revised. France wishes to raise it to 67. The UK is now talking of people needing to work long past the current limit of 65. The generous fi nal salary-linked packages that people got after retiring, usually at 60, from government or civil service jobs are likely to soon become a thing of the past. Teachers, civil servants and others who are employed locally or nationally by the state will need to contribute far more into their pension schemes. There is simply no longer money to fund massive, generous state pensions. Companies are also tightening their restrictions.

As it becomes clearer where cuts are going to occur, the likelihood of public anger spilling over into protests is going to rise. Already, there is widespread anger in France over the planned changes to the retirement age. In the UK, while there has been much talk about cuts, so far none have been implemented. When they are, the real impact will start to be seen. It will no longer be a theoretical debate, but something that is happening in the real world. We then have to get ready for protests, mass incidents and increasing challenges to government authority. This happened over cuts to public expenditure in Greece, where several died in protests in June. Governments need to communicate clearly to their populations why the cuts are happening and how they will lead to better times. Failures here could lead to major unrest. It is perfectly possible that we may see the fall of governments in the era ahead if this hugely controversial and dif fi cult process is mishandled. The bottom line is that never before has any European government needed to undertake cuts anything like the magnitude being talked of now.

International impacts

Internationally, there are two big impacts. They both have a direct bearing on China and other developing countries. The first is that most developed countries are pinning their hopes on growth to exports.This is one of the main areas where they see things they feel they can be optimistic about.And inevitably, the vast potential consumer markets in China and India figure large in their thoughts. While consumption has risen in China in recent years, as a proportion of the GDP, domestic consumption is still only 37 percent, compared to fi gures over 60 percent for the United States and the EU. The emerging Chinese middle class is of great interest to Western companies, as potential customers and as a major source of likely growth. We are therefore moving from an era in which goods were sourced by multinational companies within China for export,to one where Chinese customers themselves become the target for foreign sales efforts.This is only going to grow more intense as the years progress, simply because there are few other areas of potential growth anywhere near as large as China. If economies like the UK or France or Germany, or for that matter the United States, wish to export themselves back into healthy growth, they will have to fi nd ways to crack the Chinese market.

The second point of the international impact is longer term and more profound.As Stephen Green, Group Chairman of the HSBC Holdings Plc., made clear in a recent book, the world has changed fundamentally over the last three years. We have moved from one in which 12 percent of the world’s population live in developed countries, but consume, spend and use energy per capita many times that of people in developing countries. Things have changed. Their governments have the major debt problems outlined above. They are facing increasing competition in the global marketplace. They no longer have the kind of systemic advantages that existed in the past. This is not to declare that the old world is passing away, and that in the new world a whole new group of countries will be dominant. But it is to say that the world has become more complex, and that every country is going to have to think hard about its main advantages and work within them.Worryingly, the UK slipped from sixth to seventh place as a global exporter in early 2010.It has to work harder to be a major exporter again. Reliance on service industries has been misplaced. Now there is a need for a balanced and mixed economy.

The era of deep cuts in public expenditure in the EU, and possibly the United States, is also the start of a period of a new kind of economics. This is what countries are working out at the moment. Old frameworks are disappearing,with new ones coming into existence. As Green says in his book, this is not something that developed countries need to despair over. It is a natural development. But it is something they need to work with, and find a strategy to deal with. No one wants the world that replaces this to be as full of inequalities and unsustainability as the old one. With the right kind of policies and a new global approach, the world may well be more stable and more prosperous after going through these last few years of uncertainty and pain. And that hopefully will have meant that all of this finally served a positive and useful purpose. ■