West Midlands councils have had their budgets cut by £76 million this financial year. Jonathan Walker looks at how a flawed US study could have led Chancellor George Osborne to wield the axe unnecessarily
Authorities have faced a series of swingeing reductions in grant from central government – and there are more to come.
The effects on services are huge: Birmingham City Council announced plans in February to cut spending on services by £102 million and lose up to 1,000 jobs from the council payroll.
But could the Government’s entire cuts strategy be based on a mistake?
That’s the startling suggestion after it emerged that an influential study into the effect of debt on economies got its findings wrong.
Harvard economists Carmen Reinhart and Kenneth Rogoff published a paper in 2010 called “Growth in a Time of Debt”, which warned that economies tended to shrink when a nation’s debt exceeding 90 per cent of its annual GDP
The message was clear – if your debt amounts to 90 percent of GDP, or is getting close to it, then you need to cut spending.
But the conclusion was wrong. Rival academics at Massachusetts University have discovered the pair made a mistake in their calculations. The paper said that countries with 90 per cent debt ratios saw their economies shrink by 0.1 per cent when it should have found that they grow by 2.2 per cent.
It’s been an embarrassing period for the Harvard economists, caused apparently by an error in the way they used an Excel spreadsheet. However, this is more than a dry debate between academics in the US.
The Reinhart/Rogoff paper, errors and all, may have had a direct impact on children’s services in Birmingham – because George Osborne, the Chancellor, read the paper, and became quite a fan.
Speaking at City University London in February 2010, when the Conservatives were in opposition, he used the paper’s findings to justify proposals for deep spending cuts.
Mr Osborne said in his speech: “We will not draw all the right lessons for the future unless we understand the deep macroeconomic roots of the crisis.
“Much has already been written about what went wrong. Much more is yet to be written. Perhaps the most significant contribution to our understanding of the origins of the crisis has been made by Professor Ken Rogoff, former Chief Economist at the International Monetary Fund, and his co-author Carmen Reinhart.”
He went on too say: “The latest research suggests that once debt reaches more than about 90 per cent of GDP, the risks of a large negative impact on long term growth become highly significant.
“If off-balance sheet liabilities such as public sector pensions are included we are already well beyond that. And even on official internationally comparable measures of debt, we are forecast to break through 90 per cent of GDP in just two years time.”
Britain had to act, he told his audience, adding: “We have been warned.”
Once in power, Mr Osborne was as good as his word – cutting spending in a bid to get the deficit down. Hence, local authorities in the West Midlands have £76.66 million less to spend in the 2013-14 financial year compared to the year before. That’s the cut in “spending power”, a measurement used by the Government which includes council tax as well as Treasury grants.
It’s important to note that this is a relatively small cut in a total budget of £2.59 billion, amounting to a reduction of 1.6 per cent, but it’s only one year’s worth of cuts.
And there’s more to come.
Across the country, central government funding for councils is falling from £26.6 billion in 2010-11 to £23.4 billion in 2011-12, £22.7 billion in 2012-13 and £20.7 billion in 2013-14. The figures come from the Treasury’s Public Expenditure Statistical Analyses published last year, and are adjusted for inflation.
In fact, councils have borne the brunt of spending cuts. Health spending is increasing slightly over this period – perhaps a good thing, but it does mean other services have to take the strain when overall spending falls – while education spending is falling by only a small amount.
So the cuts are not spread evenly. Councils, police and defence are hit particularly hard.
Some critics of the Chancellor have insisted the revelation about the faulty Harvard paper proves he has got his economic policy wrong. But some caution is needed. First, the two academics still insist the thrust of their argument is right.
In a joint article earlier this month, they said: “We remain confident in the prevailing view in this field that high debt is associated with lower growth. Certainly, let’s not fall into the trap of concluding that today’s high debts are a non-issue.”
Second, it’s simplistic to argue that the Government’s economic policy is based entirely on their paper. While Mr Osborne declared professors Reinhart and Rogoff to be great influences on his thinking, it’s always possible that if they had come to a different conclusion then he would simply have picked different academics to quote.
In other words, this Government would probably be committed to spending cuts – whatever the Harvard pair said.
What’s undeniable is that the Government’s debt-reduction measures are failing to meet their goal.
The original plan was to eliminate the bulk of the structural deficit – the deficit that was caused by ordinary spending and not a result of the banking crisis – within five years.
But the Treasury has now admitted it will take at least seven years to get the structural deficit down to minimal levels, well into the next Parliament.
So Conservatives and Liberal Democrats will not have the luxury of going into the next election with a message that all the pain has paid off. Instead, the message will have to be that there is more pain to come if Britain’s debt levels are to be bought under control.
Of course, it remains to be seen whether Labour will have a different message. Ed Miliband’s party has argued that the Government’s cuts go “too far and too fast”, not that cutting spending is wrong.
All the parties are signed up to the idea that the deficit has to fall – and they believe it’s a message voters want to hear.
