July 21, 2008 | posted by Michael Baxter in Fiscal rules | comments (2) |

Government finances are in a right royal mess. According to the latest data out on Friday, in the first three months of this year total government borrowing was £24.4bn, compared with 14.7bn this time last year. And that is quite simply awful.

No wonder the government is talking about changing one of Gordon Brown’s beloved rules. But would it be right to do so?

You will recall Gordon has two rules. The Golden rule says that all borrowing to fund current account items must be repaid over the course of the economic cycle. The trouble is, it is very difficult to gauge the precise timing of the cycle. But the fact is the current account has been in deficit now every year since 2002/03. The deficit peaked in 2004/05 and improved slightly over the following three years.

But, and this is the killer, the current financial year could be the worst for many years.

As for net borrowing, that includes borrowing for capital and current account, that hit £9bn in June, following total borrowing in May of £12.5bn.

See this in the context of Brown’s Sustainable Investment rule, which is supposed to limit net debt to 40 per cent of GDP. If you exclude Northern Rock and Bank of England liability, then right now net debt is 38.3 per cent of GDP, the highest since the 1990s. More to the point, we are now just £24bn away from net debt hitting 40 per cent of GDP. It seems quite possible this will occur towards the end of this year.

Include Bank of England and Northern Rock liabilities, and net debt is already 44.3 per cent of GDP, meaning the sustainable investment rule is in tatters.

So what should the government do?

Last week we suggested that although Gordon’s sustainable investment rule is in danger of being broken, actually our net debt compared to most other developed economies is in fact quite modest.

We could justify increasing net debt, and indeed we could even justify increasing it quite a bit. The trouble is, because government borrowing on a month by month basis seems to be getting more serious, there is a danger that net debt will just carry on rising indefinitely.

But actually, the state of government finances is quite different from personal debt. In fact, you could say the situation is the precise opposite. We are not borrowing so much on a month by month basis, but total borrowing is at an all-time high.

Whereas government net debt is 40 per cent of GDP, this time last year our total personal debt actually exceeded GDP.
So, our government is in fact in quite modest debt compared to our competitors. Consumers are in very substantial debt compared to most other developed economies.

Moving forward, we have no choice but to save more. The UK saving ratio has been far too low for years. But, an increase in UK savings could have a catastrophic effect upon the economy in the short-term. If we save more, consumer spending will fall, job losses will follow, and as unemployment mounts, it will become harder and harder for the UK consumer sector to save at the levels required.

If we sit tight, and just wait for consumers to rerepay some of their excess debt, the result could be a downwards spiral, leading to a very nasty recession.

This is the paradox of thrift Keynes talked about in the 1930s. Saving at a time of an economic slowdown is the last thing the economy needs.

But in Britain in 2008 we need to see higher savings to fix the problem of debt, and the pension time bomb.

What can be done?

Maybe the logical answer is for government debt to rise, and to somehow use the proceeds to reduce personal debt.

It seems that in the longer-term that may be the only possible answer.

The government should borrow more to fund big tax cuts – probably in the form of a big rise in personal allowances. This should be coupled with a sharp rise in interest rates.

The result of such action would be threefold. Firstly, we would have more disposable income, but the rise in interest rates would mean we are more likely to save our additional income.

Secondly, we would simultaneously be able to maintain consumer expenditure so as to mitigate against a recession occurring.

Thirdly, such action would help increase the incentive among many currently on benefit to work.

Sometimes, in 2008 Britain, getting a job, or even a pay rise can be a mixed blessing. The loss of benefit that can result can mean the extra money resulting from the pay rise can be whittled away. This is true for quite a long way up the pay scale.

If you have children at university, and your income is above a certain level, then they no longer qualify for bursaries or the maximum level of student loans. Now the government is talking about subsidising rent for would be first time buyers, providing their income is below a certain level.

Throw into the equation the effect on disposable income of loss of benefits such as family tax credit, and it is not difficult to envisage scenarios right across the pay spectrum in which pay increases can actually result in less income.

Instead of the current raft of means tested benefits, a change in personal allowances would proportionally benefit the lower paid more than the higher paid. It will encourage incentive to work, and indeed to work harder, and in the long-term will thus reduce the money the government needs to spend on benefit payments.

In the longer-term this is surely the solution to government borrowing and personal borrowing.

July 18, 2008 | posted by Michael Baxter in Fiscal rules | comments (1) |

Well it’s a bit embarrassing. But is it a good or a bad move?

Some time ago we said there were two personae to Gordon Brown. There was the Dr Prudence of the early years of his chancellorship. Then the Mr Proliferate of the latter years.

Dr Prudence, it appears, is well and truly dead. Well, actually, that probably happened a long time ago, we are now just seeing the consequences of that death.

The government is considering ditching its sustainable investment rule. This is the one that limits total net debt to 40 per cent of GDP.

You can understand why. With corporate profits falling, with VAT receipts sure to tumble, presumably stamp duty receipts have practically ground to a standstill – at least on property transactions; unemployment benefit will rise, governments finances are stretched all right.

In fact, arguably, when it bought Northern Rock, government debt had already exceeded the 40 per cent level – although that is a little unfair. To arrive at that conclusion, Northern Rock liabilities were counted, but assets virtually ignored.

Gordon’s other beloved rule, the Golden Rule, which limits government borrowing to capital items only over the course of an economic cycle, is still okay – but only thanks to a shameless juggling with the facts – changing the timing of the economic cycle to suit the rules, plus a host of other changes – for example defining expenditure on road maintenance as a capital item.

Gordon set his credibility by his rules, and now they are being changed. Vince Cable said it rather well this morning on the Today programme when he said: “The government sets it own exam papers, and then marks them.”

And yet, not all of the criticism is fair.

The sustainable investment rule does not actually say net debt to be no more than 40 per cent of GDP. It just says net debt to be below a certain level of GDP – the level to be defined with each cycle. This cycle has just begun, so the government is free to change the level.

More to the point though, actually, the UK’s total net debt is quite modest. It is much higher in the US and most other European countries. So when David Cameron talks about the UK borrowing being greater than every country in the world bar Pakistan and Mexico, he is being a little unfair.

What he really means is that our new borrowing is high. Our total borrowing is actually modest.

So the UK government has an opportunity. It could conceivably borrow a lot more money. The snag is that there are structural problems with the economy. Our current expenditure is too high.

And this is where GB will surely get it wrong.

The UK can justify borrowing more – a lot more, providing the money is used to fix the structural problems. Maybe in trying to reduce unemployment in those regions of the country, places such as Hull, where it is still far too high.

The snag is that any borrowing the government undertakes will probably be used to fund more of the same old same old, to plug the gap between spending and receipts. That would be a disaster. Spending to fix structural problems would be a very smart idea.