Economics: Can the coalition government overcome its considerable challenges?

As the old election cliché goes: the people have spoken. On 6 May, unfortunately, the electorate mumbled, leaving the political outlook uncertain and confused. But in the end, it didn’t make much difference given that David Cameron is now prime minister – with Liberal Democrat leader Nick Clegg his deputy.

Much was made by all parties of the challenging outlook ahead and the need to tighten our belts. As I write, though, the UK enters its second week of coalition government – for which there is already a published agreement on its aims that puts deficit reduction at the top of its list.

The governor had offered the view that the task in hand is so daunting, and the required medicine so unpleasant, that the victor in 2010 was only likely to hold government for a single term. But he since made the unusual step of publicly blessing this union and its plans for economic reform, saying that the plans to cut spending by £6bn in 2010-11 are “sensible”.

Indeed, as the problems appear today, they look far more manageable than those the incoming government faced in 1979.

Back then, inflation was in double figures and rising, the economy was sliding into recession, industrial relations were fractured, the balance of payments deficit was widening and unemployment was well on its way to three million.

Difficult decisions were made in the early 1980s and unpleasant policies implemented, but the party in office went on to win the next three elections. If the issues are explained and the alternatives understood, the electorate has been prepared to accept, even reward, those who make the tough decisions.

This time, the hard choices were not really spelled out before the election and this contributed to the voters’ mixed response. Policymakers need to keep recovery on track without the traditional spending boost from government and consumers.

There is also a compelling need to reassure financial markets that the huge fiscal deficit and rising national debt will be managed down. What has happened to Greece has led to speculation about the UK’s credit status and the future cost of servicing the debt.

Shrinking the public sector and reducing government spending is naturally high on the agenda. But where to cut, by how much and when, had been left to the imagination of individual politicians, pundits, and the people.

Yet, just as the range of problems today is narrower than in 1979, so also perhaps has the depth of the difficulties been exaggerated. Certainly the deficit is uncomfortably high by our standards, yet it is affordable.

As a share of GDP, the current debt costs less to service than John Major’s government was paying in the 1990s. Much lower interest rates today is the explanation. And in the 1950s, the decade in which the UK recorded its fastest post-1945 growth, our national debt represented 200 percent of GDP. By 2013, the figure might rise to 75 percent on Treasury forecasts.

If the emphasis on debt management is misplaced, perhaps the focus should be on growth and how to generate it. Increasing income is a third way of paying off debt but it implies a different fiscal stance. Some tightening is needed – probably higher taxes on the personal rather than the corporate sector and more on indirect than direct taxes.

If the wrong questions are asked, the wrong answers are inevitable.

As the UK now has to endure a period of coalition government, as it did in 1974, the omens are not encouraging. It was only after five years of weak leadership 35 years ago, during which the economy weakened considerably, that we eventually found the way forward. And the government eventually supplying the tough answers was rewarded, not punished, by winning re-election.

Dennis Turner is chief economist at HSBC