April 7, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Cast your mind back to four weeks ago tomorrow. It was Budget day, and Alistair Darling tried to reassure us.

Our chancellor said the UK will grow by between 1.75 per cent and 2.25 per cent in 2008, 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.

Based on those assumptions, he went on to say 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 that was quite interesting, because, as you may recall, he is supposed to follow two rules – the famous Golden rule, and the not-so-famous Sustainable Investment rule – which is supposed to restrict public net debt to 40 per cent of GDP.  But by Mr Darling’s own estimates, in the year after next, net debt will be just 0.2 percentage points of breaking his Sustainable Investment rule – leaving a tiny amount of room for error.

And here is the worry, in making these projections, he assumed 2009 will see a pick up – whereas most expect next year to be worse than this.

Now, the Treasury Select Committee has entered the debate, and it is bad news for Mr Darling.

“The Treasury’s optimism is based on its contention that the UK economy is better placed than other OECD economies in the face of market turmoil,” said the Committee, and, “We remain concerned that some of the economy’s characteristics that have proven beneficial during past crises might prove to be conduits through which the current problems in global financial markets are transmitted to the UK real economy.”

John McFall, chair of the Committee, says: “The Treasury’s forecast of economic growth in the next two years is more optimistic than the consensus view… There are significant downside risks to the economy and therefore potentially to tax receipts.”

The Select Committee is right.     The current economic crisis relates to debt – and countries that see high levels of consumer debt are most vulnerable, and the UK is near the top of the list.

Recall comments made by the IMF last week: “Particularly at risk [is] the UK housing market, where the financial crisis is exacerbating issues of affordability and general economic gloom”– it seems absurd to claim that the UK is better placed than other OECD economies.

March 13, 2008 | posted by Michael Baxter in UK economy | comments (0) |

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.

March 13, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Aside from burying his head in the sand, and doing his best to cure all insomniacs of their unfortunate affliction, the chancellor did make a few announcements yesterday of some vague interest.

Actually, if you work in the pub industry, there was a lot more than vague interest. Pubs are suffering at the moment, thanks to the smoking ban – now they are set to suffer some more.   Beer is going up 4p a pint, wine 14p a bottle, and spirits by 55p a bottle.

There’s an argument to be made for saying these were good tax rises – as they are a step in the direction of fighting binge drinking. This may or may not be a valid argument, but there is no doubt, the pubs and clubs industry is set to be even worse off thanks to this budget.

A tax on plastic bags is also arguably a good move – and let’s face it, if you are worried about the cost of plastic bags, all you need to do is hang on to them for longer.    But at the same time, this tax is hardly earth shattering – the fact that it made the headlines just showed how inconsequential this budget was.

The chancellor said he was postponing the 2p rise in fuel duty to October – well, with oil so high in price he had little choice.

From 2010, new cars that are low-polluting will  require zero car tax in year one, while high polluting cars will require £950.    As Harold Macmillan once said, the devil is in the detail, and sure enough, if you drill down you see some apparent anomalies. One press report pointed out that owners of some Bentleys will pay less car tax than owners of  some family saloons.  But that is missing the point, the chancellor wanted to tax pollution, so we pay the true cost of our motoring, he was not trying to tax high living.

He also announced measures to reduce child poverty – that is very laudable – but the money involved is actually quite modest.

One of the more interesting ideas was for £12.5m going into a venture capital fund for investing into women-owned businesses.

The money is tiny but at least it’s an interesting idea.

But surely the real story of this budget is in what it didn’t do? See story above.

March 12, 2008 | posted by Michael Baxter in UK economy | comments (1) |

And while markets were busy saying Phew yesterday, one man was quietly beavering away in his study, preparing for his budget to rescue the UK. 

Yes, our silver chancellor is beginning the biggest day of his career to date. Poor old Al.   it’s not been a good time at number 11.  Gordon Brown was often called the lucky chancellor, his successor seems to have the opposite characteristic. What would Napoleon have made of all this?  He once famously said after being presented with candidates to replace one of his generals, “I want none of those. Go back and find me a lucky general.”

Mind you some of the problems were of Al’s own making.    The changes to capital gains tax, and his plans for nondoms, do smack a little of an idea suggested by his daughter after a day at school.  But this afternoon, the real attention should focus on what he can’t do – and this time, it’s not his fault. If you believe the UK is set to follow the US, and we are running around 12 months behind, then we really need to look at the mistakes made by the Fed and US government a year ago, and make sure we don’t repeat those mistakes.

Right now the Fed is doing a passable impression of someone in panic mode – maybe if it had taken some of the action it is taking now a few months earlier, all this mess could have been avoided.     Then again, with inflation building, it had little choice but to keep rates at 5.25 per cent for as long as it did.  The Bank of England is similarly hamstrung – a big cut in rates now may avoid recession in 2009 – but the underlying inflationary pressures could lead to  a much worse crisis in the years that follow.    Besides lower interest rates encourage more borrowing.  It’s what Keynes called pushing on string.    If there is too much debt, the last thing you want to do is encourage more borrowing.   Instead Keynes argued that a crisis of this type required tax cuts for the poor.

 Why the poor?  The reason why the poor got the benefits of Keynes’ ideas was not so much down to some ideal, rather it was down to pure economics.  The poor have a lower savings rate, therefore if they get a tax rebate they will spend the proceeds, and their money will then spread across the economy.    The rich are more likely to save the proceeds – or in  modern speak, invest it into property.  Well that’s the theory anyway.

Now interestingly, that’s what the US did.  Arguably they were a little late – but earlier this year George Dubya announced a $150bn tax give away – the equivalent of $800 for every US taxpayer – even more for households with two income earners. Now imagine the impact such a move would have upon the UK if Al announced a similar move today.  Fears of a recession would disappear,  and Al’s silver crown would sit beneath a halo. But he can’t do that.    His lucky predecessor, or is he Alistair’s unlucky boss, spent all the money.  When times were good. Gordon spent. The UK probably faces the most serious threat to its run of positive economic growth since the run began in the early ‘90s, yet government finances are in crisis.  Whether there is a halo above Darling’s crown or not, it’s a right royal mess.