Quite early on in the chancellor’s speech yesterday he said, “Given the fundamental strength of our public finances, it is right to allow fiscal policy to support monetary policy in the period ahead in helping to maintain stability in the face of the global downturn.” Just for a moment, the budget seemed interesting. Was the chancellor set to announce measures to boost the economy at its time of need? Had Mr Darling, perhaps while on the road to Damascus, woken up to the danger the UK could hit recession, and was preparing a fiscal boost to stop that from happening. Had he spotted the mistakes made in the US, where the government is attempting to boost the economy with a $150bn tax boost – but is just too late to stop US recession? Did Al realise that the time for such action is now, not later?
The answer to those questions: alas it is No.
If there was one theme to this budget, it’s that what the chancellor said he was going to do, and what he actually did, were two quite different things.
So, the latest resident of number 11 reckons the UK will grow by between 1.75 per cent and 2.25 per cent in 2008 – that’s down from his last estimates, but still well clear of recession levels. Then Mr Darling reckons the economy will pick up, and grow around the level of the long-term average of between 2.25 per cent to 2.75 per cent. He then expects the growth to stay at around that level.
In other words, Mr Darling reckons the UK’s growth story will see a slight easing this year, before going back to normal.
And on this assumption he says government debt levels are forecast to be 38.5, 39.4, 39.8, 39.7 and 39.3 per cent of GDP by 2012/13. Now actually those projections are quite interesting. You will recall when he was chancellor, Gordon Brown defined two rules – the Golden rule and Sustainable Investment rule. This latter rule limits total government debt to 40 per cent of GDP. In other words, by Mr Darling’s own estimates net debt will go within a whisker of breaking this rule in two years’ time.
Okay, so what’s the panic – it doesn’t matter if he nearly breaks one of those rules – the key is that the rule is not broken.
The trouble is this. Do you really believe the UK will grow as strongly as Mr Darling says?
The current economic turmoil actually has deep underlying causes, that have manifested themselves in other forms. The underlying problems are as follows, economic growth over the last few years has depended on consumer borrowing. This has in turn been fuelled by high asset prices making people feel as if they can afford to borrow more. Cheap asset prices were possible because of low interest rates – that were enabled because of low inflation, thanks to cheap goods from China and technological advances leading to greater productivity.
Even while inflation stayed low, it seemed that sooner or later asset prices would fall – creating economic shock.
But now, those benign external factors that enabled growth and low inflation, have come to and end. As a result, asset prices are close to crashing in the US, and could follow suit in the UK.
The US, it seems, is in recession right now; the UK’s economic cycle, it seems, probably lags around 12 months behind the US.
The time when the UK will be most in danger of recession is next year, the very year Mr Darling expects an uplift.
It seems likely Mr Darling’s current estimates for growth this year are optimistic. As for the year after – they are grossly optimistic.
So if growth is to be lower than expected, tax receipts will be down, benefit payments up, and borrowing much higher than Mr Darling expects. The Sustainable Investment rule will be broken.
But if it is broken, will it matter?
In his budget, he continued to emphasise how government finances are in better shape now than in the past. “In the early 1990s as much as three quarters of all new public spending went on debt and social security costs. The figure is now just a third of that – allowing us to target spending where it is needed,” he said.
“This year,” he said, “debt will be lower than the US, Euro area and Japan.” Actually he is right. Total net debt in the UK is much lower than in nearly every developed economy, In 2006, not only was net government debt higher in the US, Japan, Germany, France and Italy – in all of these countries net debt was far in excess of 40 per cent of GDP. In fact in the US, Germany and France, net debt as a percentage of GDP was approaching twice the level seen in the UK. In Italy and Japan it is much higher still.
Our total government debt is modest. It is our current borrowing that is high.
There really is a danger the UK will hit recession next year. By taking action now, it can be avoided.
The UK’s problem is the massive and growing level of consumer debt – combined with high borrowing in the public sector.
Our strength is that total public debt is still modest.
We could allow total debt to grow, and spend the money then freed-up on tax cuts. This would help ensure the UK avoids recession. If, at the same time, the rate of interest is kept at present levels – inflation can be avoided, and consumers will have both the incentive and the wherewithal to start repaying debt.
Earlier this week, we told how a report from CEBR showed that public spending in the UK as a percentage of GDP has overtaken public spending in Germany for the first time since James Callaghan was Prime Minister.
The CEBR data also showed how in some regions, London, the South East and East Anglia, public spending in percentage terms was still modest. CEBR said, “Parts of the UK have become so dependent on public spending that it can crowd out private enterprise in these regions and countries. It is partly a chicken and egg situation – public spending in these regions is high because they are doing less well economically, but on the other hand a high public spending share can make a revival of the private sector difficult to achieve. And the latest data suggests that this problem is getting worse.”
Right now, the government can use the fact that total public debt is still modest, to boost enterprise and incentives to work through lower taxes and credits on enterprise – maybe credits which are greater in areas of higher public spending, and at the same time try to reduce reliance in these regions on public spending.
This will create underlying structural strength, will mean government borrowing will reduce and in the longer-term the UK will boast a much stronger economy.
Instead, the chancellor, who seems to exist in a form of denial by refusing to acknowledge how serious the current economic crisis is – has merely made the chances of a recession that much greater, and the recovery, when it occurs, all the weaker.
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