Between the Lines: Economic experiment that has the world's eyes on UK
However, by imposing an extra 40 billion of tightening (lower spending and higher taxes) on top of the 73bn already planned by the previous government over the life of this parliament, the Chancellor is turning the UK economy into a live economic experiment. The 113bn total equates to a total tightening about 8 per cent of the size of the economy over five years - historically very ambitious.
As with Mrs Thatcher's assault on government spending in the 1980s, all the "cuts" are in fact reductions in spending plans. In fact, government spending is still expected to rise in every single year of this parliament, and be 11.5 per cent higher by 2015-16 than the current financial year 2010-11. However, due to the rapid increase in government spending in previous years, the decline in the rate of future growth in spending will have a significant effect on the rate of growth of the economy as a whole.
The UK political system and economy have also never experienced public-sector spending cuts on this scale - it will necessitate a drastic re-appraisal of the purpose of spending across all departments. The detailed, department-by-department allocations to be announced in October will give the real impact of what this fiscal tightening will really mean.
From an economic perspective, frankly this is a "Kill or Cure" approach to the UK's economic problems. The deficit is expected to fall from 10.1 per cent of GDP in 2010-11 to just 1.1 per cent by 2015-16, with a structural surplus of 0.8 per cent in that year. This is achieved by a total of 113bn of fiscal tightening, the 73bn planned by the previous government and the further 40bn announced recently.
Indeed it is this which will be the subject of this experiment. The government is seeking a much more aggressive reduction of the budget deficit than the previous government did, and probably more than it needed to do to satisfy the financial markets. The clear risk is that such a dramatic tightening damages demand in the economy so much that it sends it back into recession. The probability of this materialising rests on two factors - first what happens to the global economy and the prospects for exports, and second the size of the "fiscal multiplier".
A strong global economy would clearly help UK exports enormously - however more than 50 per cent of UK exports go to Europe which itself is engaging in major fiscal austerity. US economic prospects are a little brighter with continued population growth, a relatively healthy banking system and as yet no drive to fiscal austerity.
It is only in the emerging world where prospects still appear rosy - economies such as China and Brazil, have large populations with little debt, and a great desire to enjoy a higher standard of living. Overall the outlook for the global economy is mixed.
The "fiscal multiplier" measures the degree to which changes in government spending impact the real economy. In justifying extra government spending at times of economic problems (as was the case in 2009), politicians implicitly assume that the fiscal multiplier is relatively high, so that the extra government spending encourages the private sector that the economic outlook is healthy so that they too spend more. By contrast, this government is assuming the fiscal multiplier to be relatively low, so that a reduction in government spending actually has relatively little impact on the private sector's decisions to spend.
Thus the world's economists now have the luxury of observing a real-time experiment into the size of the fiscal multiplier in the UK. If the government is wrong, then the scale of the tightening will send the UK economy into a period of weak growth or recession, which will make it very difficult to actually reduce the budget deficit. There appears to be no Plan B if this does occur. On the other hand, if the government is correct, then a renewed and better balanced UK economy could be the result in a few years time, with a much stronger focus on export and investment demand.
The economists of the world are watching us closely.
• Jeremy Beckwith is chief investment officer for wealth managers Kleinwort Benson.x