In the wake of the recent Irish debt crisis, the UK Coalition government decided not to take part in a new rescue fund for troubled eurozone members, suggested by France and Germany. This decision comes in spite of the UK's pledge to support the EU-IMF rescue efforts for Ireland through a bilateral loan of more than £3bn of its own, knowing full well that its banks, especially RBS and Lloyds, are heavily exposed to the troubled Irish economy. Worse, it has also come amidst the increasing likelihood of the UK soon being in need of a bailout itself.
The general debate on the effectiveness and purpose of unprecedented cuts in public spending has so far been thoroughly dominated by the public quarrel between the supporters of further stimulus spending and the supporters of the Coalition government's austerity policies. In essence, this debate has centred on the question of what is the surest way back to growth. What few seem to contemplate, however, is the more general problem of where this growth should come from. Both groups seem to take for granted that this would be the 'global' economy.
Given current developments in the international system at large - i.e. increasing great power competition, the emergence of a more multipolar world order, escalating currency wars, rapidly growing global imbalances, and increasing protectionism - those that still think growth based on a revitalised 'global' economy is still a serious option should think again. In the absence of a general global economic recovery, the continuation of global free trade, a further liberalisation of international markets, and a rebalancing of the global economy (especially more domestic demand in surplus countries, first and foremost China and Germany), the Coalition's policy of collapsing public spending absent private sector growth should be seen as what it is - sheer economic madness. Rather than to reduce the deficits, austerity measures will heighten them further.
But let us have a look at the issues: The Coalition's main argument is that by scaling back the public sector, the private sector will fill the void and private sector-led growth will resume. Coupled with a policy of further deregulation, especially of the labour market and social welfare system, and by encouraging innovation (hard to see how this is meant to be achieved given the massive spending cuts on education and the absence of a mechanisms encouraging private sector investments in the domestic real economy), the Coalition government's entire economic policy rests on the assumption that for growth to return, Britain needs to become more competitive in 'global' markets.
The question is, however, competitive against whom? Against emerging markets? Hardly. Britain simply does not have anything resembling a viable industrial sector left that could become more competitive. And even it had, it would never achieve the level of competitiveness in unit labour costs required to compete on par with low-cost Asia. So when the Coalition government talks about competitiveness, it can surely just refer to Britain's financial and wider service sector.
But a lack of competitiveness has never been the problem with this sector in the first place. Rather, the protectionism of emerging markets, first and foremost China's, and their decision to shield especially their banking sectors from western penetration has been the real issue. The City and Wall Street have attempted to break into these markets for decades, failing miserably. China in particular has simply dodged any pressures to open its market to the western service sector and will continue to do so while becoming ever more competitive itself, even in those sectors the West considered its sole prerogative such as high-tech industries and high-end manufacturing (Germany be aware).
With these realities in mind, the cuts will only achieve the following: They will further contract domestic demand (especially since it still does not appear likely that the easy credit to UK consumers will return any time soon), drive up unemployment and hence, aggregate social welfare costs despite current cuts on social welfare spending as well as stifle rather than spur future innovation.
That means that rather than to reduce the deficits, the increasing need for public spending to compensate for the lack of private sector growth will drive the deficits up further, even beyond previous levels. Interest rates are then likely to rise, spending on debt repayments will increase, financial markets eventually lose faith in the British economy and its ability to repay its debts, driving interest payments up further, putting further pressure on the deficit and on employment and so forth. The downward spiral we will get into will be extremely hard if not impossible to reverse.
This will eventually leave Britain no choice but to join a larger currency zone that can extend its helping hand once financial markets finally turn against it and ensure the availability of future credit lines. It is not as if further stimulus spending will get Britain back to growth either given current global developments - thus allowing eurosceptic Britain to avoid joining the euro - but at least it will prevent the further destruction of what is left of Britain's real economy and preempt the very real danger of escalating social instability and unemployment.
