How the Comprehensive Spending Review effects entrepreneurs

This is an interesting short take on how the Comprehensive Spending Review impacts the entrepreneurial economy from Jeremy Beckwith, Chief Investment Officer at Kleinwort Benson. We have highlighted, in italics, what we think are the key points.

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1. Impact on the financial markets

The stock market, the gilt market and the foreign exchange markets were all unchanged during and after the chancellor’s announcement. The framework and key numbers for economists were announced in the June budget and there were no substantive changes to these.

2. The Cuts

Total government spending is planned to rise by 5% in cash terms over the next 3 years; over that period, inflation is expected to be 6%. So in real terms government spending is effectively frozen. However debt interest and welfare spending are set to grow strongly due to the effects of the recession, and the Conservatives made manifesto commitments not to make cuts to NHS spending and overseas aid. In addition within the CSR they decided not cut current spending on schools (though specifically excluding capital spending and university funding).

The effect of having these “protected” areas is that the full force of the cuts will bear down on the “unprotected” areas, such that they will on average have funding cuts of 19%. This is the total impact in 2014/5 compared with this year’s funding levels, but the cuts are spread evenly over the 4 year period.

Total cuts are estimated at £81bn, £2bn less than expected in the June budget as a result of smaller cuts in capital spending projects.

The most used word in the speech was “fairness” – cuts in government spending in isolation are almost bound to be regressive, given the significance of welfare spending in total spending, and indeed the data do show a greater impact of these cuts on living standards as one goes down the income distribution. However the results are far less regressive when account is also taken of the changes to income tax, announced by the previous government.

The announced cuts in welfare spending are significant: – for non-higher rate taxpayers the cuts are expected to be £15.5bn, equivalent to £100 per month reduction in income on average for the poorest half of all households across the country.

3. Impact on the Economy

From 2000 to 2007, public sector spending grew by 4% per annum in real terms and private sector spending grew by only 2%, giving total UK GDP growth of just under 3%. For the next 4 years, the Chancellor has told us to expect public sector spending growth of 0% in real terms. If the private sector is able to achieve once again the 2% growth it managed in the last decade, then total UK growth will be a little under 1% for the next 4 years. To keep the rate of unemployment stable, the UK has historically required growth of 1.8% – this will require the private sector to grow at 4%, something only managed in 2000 and 2007 in the recent past.

One big hurdle for the private sector may well be that in the last decade this 2% growth rate was achieved at a time when UK bank lending was growing on average at 14% per annum – today bank lending is shrinking at a 3% rate. Financing this future growth will not come from the banking sector.

To achieve these growth rates in private sector spending will require the UK’s entrepreneurs to be confident in the future and seeking to expand – historically new job creation tends to come from the small and medium-sized companies rather than the largest companies, who are able to choose to locate jobs in any part of the world. It is the success of the nation’s entrepreneurs that will determine our economic performance over the next few years.

It is likely that with a weak outlook for domestic demand, our businesses will have to find greater overseas demand for their goods. The 25% fall in the pound in the second half of 2008 should have made the UK much more competitive in global markets, though to date this cannot be seen in the balance of payments data. The combination of tight fiscal policy and easy monetary policy (with the MPC yesterday hinting at the possibility of further Quantitative Easing in the next few months, would normally be expected to produce a weaker currency going forwards. However these are strange times in the foreign exchange markets, with both the US and Japanese policymakers also expected to adopt further QE policies, and many emerging countries actively intervening in the markets to stop their currencies rising.

4. The Housing Market in the South-East

A combination of a cap in the amount of housing benefit which will be paid to any claimant, the cap on total welfare payments at £26,000 per annum, and changes in the Social Housing Allowance which will increase the rents payable to 80% of the free market level, may well have an unexpected impact on the South-East housing market. Given the shortage of housing in the South-East and consequent high levels of house prices and of rents, many low-income households are likely to be unable to afford to continue to live in their current homes, and will need to find cheaper accommodation. Such accommodation may not even exist in the South-East. This might “free up” a lot of property in the South-East housing market , mitigating the current shortage and leading to lower prices and rents in the private sector, or it might put a lot of pressure on employers to pay the London “Living Wage” which itself might have to rise to offset the effects of these cuts in housing allowances.

5. Plan B

There does not appear to be a back-up plan at the Treasury, should these cuts turn out to be so severe that they drive the economy back into recession. At that point a choice would have to be made between not cutting as much as is currently planned in order to maintain demand in the economy at the cost of a widening deficit, or sticking to the planned cuts and toughing out the recession. Another alternative would be to follow the Irish example where a deteriorating deficit following cuts and recession, merely led to even greater cuts being necessary in order to keep the deficit as low as possible.

This round of spending cuts has been described as a live economic experiment – we should all be hoping that it is successful, the implications of failure are deeply disturbing.”

Jeremy Beckwith, Chief Investment Officer, Kleinwort Benson

To paraphrase:

‘The macro economy sucks, growth can only possibly come from the private sector and the only part of the private sector that can create employment is entrepreneurial SMEs but don’t expect any help from the banks’.

Entrepreneurs of Britain, it is sort of up to you…

Next BLN event: Our next CEO Tales event will be held on Thursday 4^th November 2010: ‘Scaling Digital Businesses’. We will be joined by David Soskin, author of, Net Profit’ and Steve Purdham, CEO of We7, to talk about the challenges of scaling a digital business successfully. We are also running a small interactive workshop prior to the event, Maximising Your Value on Exit. This will run from 17.00-18.00 at the same venue. If you would like to participate in this workshop, please contact us and let us know in less than 10 words why you would find it valuable.

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