The black hole caused by budget cuts won’t be filled by export growth

By Matthew Pitt

Almost every oral question asked by the opposition in the commons is currently answered by the coalition government in the spirit of the blame game: “we are in this situation because of the last government and we are now cleaning up the mess that it left behind.” The strategy to deflect fault upon the Labour Party is doubtlessly working according to recent YouGov polls, albeit not for the Liberal Democrats. But at some point in time, as is the case with a child becoming an adult, one needs to begin to take responsibility for one’s actions. This applies especially to the premature budget cuts proposed by the coalition government that will withdraw a vital support for the fragile economic recovery. As a consequence for the UK to return to former growth figures requires, amongst other things, a surge of growth in the export sector.

On the back of a depreciation of sterling by 25% since 2007, Osborne expressed his belief that the economy will shift towards exports and away from domestic consumption. If this were to happen, then the financial black hole caused by the radical cuts to governmental departments averaging 25% within the next four years would be offset – at least partially – by a significant reduction in the trade deficit. As it turns out, his optimism surrounding the UK’s economic growth prospects in the immediate future, based on an export-led hike, is now being put into question.

New figures released by the Office for National Statistics may turn out to be the first of many that offer grim reading for the Treasury. Described as the worst set of UK trade figures since the Second World War, they showed that the British economy was burdened by a £13.2bn deficit between May and July, far more than expected by city analysts. In July alone, it noted a massive £8.7bn trade deficit in goods, the largest record for a single month.

Export figures were already so low prior to the three months to July; growth was inevitable. And it did grow, but only by a mere 7%. As a result, the hope for outside markets to play a major role in supporting a stable and healthy UK economic growth is being significantly undermined by exports failing to rise sufficiently.

In economics, confidence plays a central role. Take, for example, investment and employment decisions made by firms. If the economic future looks bleak, then it won’t seek to expand or take on a greater number of full-time workers. Equally, if consumers foresee a contraction in their disposable income they will begin saving proportionately more, and therefore keep desperately needed money out of circulation.

The good news: economic analysts were positive about the show of strength by the domestic economy during the summer, rising by 20%. Philip Rush, economist at Namura, stated that domestic demand growth is likely to continue to drive GDP. The bad news: world trade is slowing down at a rapid pace, diminishing the opportunity for UK exports to bounce back, which is expected to have a negative impact on confidence in Britain’s future market performance.

Data published by the OECD on Thursday showed how the British economy will experience a sharp downturn in the remaining months of 2010, diminishing from 1.2% to 0.4% by the end of this year. Accompanied by the Bank of England putting quantitative easing on hold, what will replace the huge gap caused by an overzealous Osborne in his crusade of public cuts?

Combined with the fragile state of the banking sector and the rumours circulating in the media concerning the exodus of banks out of the City, the factors supporting the revival of the economy are on shaky ground. Together with the probable confidenceslump in the near future with weakening economic growth, the budget cuts will inevitably have a direct effect on the confidence of businesses to take risks on an insecure export market. It seems the external sector, for one, is not the answer to drive the economic recovery once domestic consumer and government spending begins to fade.

Stuart Green, an economist at HSBC, commented that “if doubts over the sustainability of the UK recovery are to subside, these figures need to show a very substantial turnaround over the coming months.” If not, the fragile state of confidence in the consumer and business sector will initiate a severe downturn with significant consequences on demand and supply. The situation is likely to worsen further after the austerity package by the government is revealed on October 20th that will cut public spending by an additional £32bn by 2014-15 (compared to plans proposed by Labour).

Osborne needs to wake up and see sense in Labour’s proposals to gradually implement an average of 20% spending cuts across Whitehall departments only once the economy has been supported sufficiently and doubts addressed in order to avoid endangering the current feeble and fragile economy.