SUNDAY TIMES 30.11.08
Only spending cuts will get us out of this black hole
David Smith: economic outlook
Like so many things in this crisis, the story of the public finances
is one that makes everything that went before seem trivial. The long
debate between the Treasury and independent experts came down to
whether there was a "black hole" in the government's projections that
would have to be filled by a few billion of tax rises.
The context was Gordon Brown's fiscal rules which, as he put it in
his final budget last year, were "the foundation of the strength of
Britain's finances".
In that same speech he scoffed at "a deficit equivalent of over £100
billion in a single year in the early 1990s" and looked forward to
public borrowing trending down from £35 billion, its level then, to
£24 billion, comfortably meeting his golden rule.
I apologise if you wondered what the fuss was about. If Stephen
Hawking has the definitive take on "black hole", I regret suggesting
that what we were talking about was worthy of the name.
For what Alistair Darling unveiled last week was the biggest,
scariest black hole in modern times. As I understand them, black
holes are something you can never escape from. The chancellor's
numbers suggest that description fits pretty well.
Public borrowing, £37 billion last year, will be £78 billion this
year, a huge £118 billion in 2009-10 and £105 billion the following
year. It will rise to a modern record of 8% of gross domestic product
and not drop below 3% of GDP - which should be the upper limit for
borrowing - until 2013-14.
For government debt, 60% is the new 40%. The old rule of keeping
public sector net debt below 40% of GDP has turned into a hope it
will stay under 60%. For debt to fall, we have to wait until the
Olympics, not 2012 in London but 2016 in Chicago, Madrid, Tokyo or
Rio. That is when, according to the Treasury, debt will edge down
from a peak of over 57% of GDP. It is also when the current budget,
which in normal circumstances is supposed to be in balance, gets back
there after years deep in the red.
These were X-certificate projections, the more so since they are
dependent on a short and shallow recession but one which,
nevertheless, results in some 4% of economic output being permanently
lost.
Next year's borrowing alone has been revised up by £80 billion since
the budget. Borrowing over five years is up by £295 billion, brought
about almost entirely by a collapse in tax revenues, from the City,
from the corporate sector and just about everywhere else. Government
debt will indeed double, from £527 billion at the end of March to
£1,084 billion in 2013-14.
What should be done? Public spending is part of Darling's solution,
with its growth rate to slow to 1.2% a year and capital spending,
previously sacrosanct, to drop as a share of GDP from 2010 onwards.
The Institute for Fiscal Studies said these adjustments mean spending
will take a bigger share of the burden of getting borrowing back down
than tax rises, which include, from 2011, a 0.5% rise in employer and
employee National Insurance contributions and the new 45% top rate of
income tax on high earners.
That may be so. But is it enough? Next year the government will have
expenditure of £654 billion but receipts of only £536 billion. The
recession has bitten hard into the tax base. The economy that emerges
from it will have fewer revenue cash cows of the kind provided by the
City and the wider corporate sector in the past.
What should you do when the tax base has been permanently damaged? We
have to cut our coat according to our cloth, by reducing spending.
This should not happen immediately, but it should happen. The public
spending splurge of recent years was based on a false premise, which
was that the revenues would always be there to pay for it. They will
not be.
In past episodes of economic difficulty, it often required external
voices to exert the discipline that politicians, left to their own
devices, found difficult. The most famous was the International
Monetary Fund bailout of Britain in 1976.
The IMF insisted on a sharp reduction in public spending, more than
4% in real terms in 1977-78. At other times, even without the IMF,
public spending has been cut to rein back borrowing; between 1985 and
1990 it was reduced by 3% in real terms and between 1996 and 1999 by
over 2%.
Of course this is never easy. But the new era we have entered demands
that it has to happen. [As I have been saying for about a year now! -
cs] The question is whether the politicians are brave enough to say so.
What about the short term? The pre-budget report's centrepiece was a
temporary cut in Vat from 17.5% to 15%, from tomorrow, and rarely
have I heard such whingeing from retailers in response.
I hope the Treasury remembers this next time. Perhaps the chancellor
should have gone straight for a 2.5 point rise in Vat, as happened in
1991.
The tax cut will not suddenly make people buy flat-screen TVs but
means we will pay £12.4 billion less Vat over the next 13 months. It
gives some real income growth for households. It adds to the deficit
in the short term, though not much; without it next year's borrowing
would have been 6.9% of GDP; with it the figure rises to 8%.
At the margin it will increase consumer spending, which has not grown
as rapidly as people think. Before the downturn, spending over the
latest five years had grown at only two-thirds the rate of the
previous five, and slower than the five-year period before that.
The effects of the Vat cut should be compounded by further speedy
interest-rate reductions. The "shadow" monetary policy committee,
which meets under the auspices of the Institute of Economic Affairs,
wants a full-point cut on Thursday, which would take us to 2%,
equalling the lowest Bank rate since 1694.
Monetary policy is being dramatically eased. So is fiscal policy,
both by accident and design. The big requirement, though, is a
credible plan for getting us out of that budgetary black hole in the
medium term. That has to mean lower public spending.
========================
SUNDAY TELEGRAPH 30.11.08
1. How on earth did we get into this mess?
Listening to Alistair Darling's speech last Monday, I had a surreal
experience.
By Roger Bootle
It was as though I had listened to it before. You see, during all
those awful Brown budgets, although I never knew when, I always knew
that it would end like this. You know the stuff, "I am today spending
squillions to provide help for hard-working families, cutting the
basic rate of tax, and all the while the nation's debt is falling. We
are the best performing of all the G7 countries. Best economy in the
world; fastest growth rate since Hereward the Wake, etc etc."
Remember all that stuff?
But even so, I am still puzzled about how we allowed ourselves to get
into this mess. It is tempting to say that the Government fooled us.
But the truth is that they first fooled themselves. And not only the
Government. The whole establishment and most of the commentariat fell
for it. We have passed through a mass delusion of gross proportions.
Such things are not that unusual. The late John Kenneth Galbraith
explained that to have a bubble economy, more than just a few
speculators need to be taken in. The whole system has to believe it.
Otherwise, it won't get going. But in the best bubbles the whole
system does believe it, not least because, in the short term at
least, it pays to believe it.
This was a delusion about the level of prosperity and about what it
derives from. Some aspects were shared internationally; some were
purely British; but they were all old hat. It was the combination and
the scale which made the effects so devastating.
There were three elements. The first was something about which I have
waxed lyrical for years - housing. That the bursting of this bubble
would cause severe trouble I never doubted. But I had not seen quite
how much trouble because I had not reckoned just how vulnerable the
banks were.
The second delusional aspect was a British classic - the current
account of the balance of payments and the pound sterling. Whenever
there is a crisis in the British economy the pound is at the bottom
of it. After we came out of the ERM in 1992, sterling languished at
low levels for 4 years. This was one of our most successful periods
of economic management.
The pound then began a rapid ascent before Labour came to power in
1997, and it carried on subsequently, reaching a peak roughly equal
to where it had been under the ERM regime. It then enjoyed a long
period of stability - but stability at the wrong rate. After its
recent fall, the pound is now just about back to where it was in
those years after the ERM exit.
The high pound was one of those delusions which was wonderful to
believe in. Not only did it mean that imported goods were cheaper,
but overseas holidays too were cheaper. And the newly enriched
British went a stage further - buying overseas properties. Some even
reached the third degree - portfolios of buy-to-let properties
overseas. And, of course, cheaper goods helped to keep the inflation
rate down, which encouraged the Bank of England to set interest rates
very low, which underpinned the housing boom.
The third delusion was that we could go on borrowing like the blazes
to fund the creation of make-believe jobs in the public sector. This
delusion was multi-faceted - that the private economy was strong
enough to bear the burden of the bloated public sector; that the
economy would never experience a severe downturn which would
undermine tax revenues; that the tax-take could go on rising, even
though it rested to a large extent on two of the most vulnerable bits
of the economy, namely the housing market and the financial sector;
and that all extra jobs in the public sector were real.
These three aspects of the delusion were closely linked. Accordingly,
it is unsurprising that they have all collapsed pretty much
simultaneously.
As regards the effects on our future, after last week's dire
borrowing numbers from the Chancellor, most attention now focuses on
prospective tax rises. But the end of the other delusions will
require some major adjustments also. For millions of people, rising
house prices have seemed like the road to riches. Holidays, cars,
school fees, everything, could be financed by these magical bits of
bricks and mortar. What is the point of saving when your house will
do it for you? These people will now experience the cold winds of
economic reality. For some people, rising house prices seemed to
guarantee a comfortable retirement. With pensions squeezed and now
their nest-egg reduced, they will surely feel the need to tighten
their belts.
The scale of the shift in resources implied by the need to adjust the
international trading aspect of the delusion is widely
underestimated. Our overall trading position, including services and
investment income, has been running a deficit of roughly 4pc of GDP.
To bring this to balance would require a corresponding squeeze in the
other parts of the economy. The public sector is supposedly going to
trim back a bit but the lion's share of the adjustment will have to
come from consumers.
What will happen initially is that we will buy less from abroad,
because the stuff is relatively more expensive, including foreign
holidays. But if we are to recover from this ghastly mess the process
will have to include strong growth of exports. As and when that
happens, it will boost GDP and employment but it will do nothing,
directly, to boost consumption. In other words, there will be years
ahead when the growth of consumption is below the growth of GDP,
pitiful though that might be. For some time, we will be making
additional goods and services for people abroad, without the quid pro
quo of receiving imports in return. We will be doing this in order to
reduce our borrowing from abroad.
If it is any consolation, our problems are not uniquely British. The
first aspect of the delusion was international. The second, though,
was not and could not be, because for every current account deficit
there must be a surplus. It is striking, however, that the US, which
was a sufferer from the first delusion, also for many years laboured
under the second. There are some countries, besides ourselves, which
have had a dose of all three - for example, Spain, Greece and Italy.
But no other major country is as badly placed as we are.
May I suggest a new index of the three delusions which puts them on a
common footing? To borrow from Gordon Brown, on such an index we
would come out about the highest we have ever been - and the highest
in the G7.
----------------------------------------------------
roger.bootle@capitaleconomics.com
Roger Bootle is managing director of Capital Economics and economic
adviser to Deloitte.
============
3. Chasm between the two Britains is laid bare
By Michael Fallon
'It is not until the evening that one can see how brilliant the day
has been" is one of the Prime Minister's favourite classical
quotations. But it is not until the evening of this Government that
we can see the full measure of the damage Labour has done to our
country.
As the recession clears away the rhetoric, we begin to understand how
Brown created two Britains. Beneath the explosion in credit and the
boom in house prices, only the public sector was actually expanding,
"creating" three-quarters of all new jobs since 1997. The private
sector was becoming more efficient, stripping out layers of middle
management, out-sourcing back office functions, installing IT that
improved productivity.
Now it's the private sector that's in the firing line. Our wealth-
creating companies are shrinking fast. In every town, long-standing
family firms that have survived world wars and previous recessions
are shutting their doors.
Those over 50 may never work again; all face a poorer retirement
because of Brown's pension tax and the stock market collapse. Even in
the City of London, those much-demonised bonuses are already being
cancelled at a stroke of a pen. For the first time since the
mid-1970s middle Britain is facing a savage drop in its standard of
living.
But the other Britain is cushioned. Over five million public sector
employees are protected: they can't be "let go"; their working hours
can't be increased to improve productivity or reduced to cut costs.
Their salaries are index-linked - they can't be "invited" to take pay
cuts. Above all, their pensions are guaranteed, fixed to final
salary, and paid for by the private sector.
There's a fundamental issue of fairness here. It's bad enough that
only private sector workers can be fired on a Friday. But now, we are
told, those middle-earners who hang on to their jobs will be taxed
yet more to pay for the privileges of the public sector (and yes -
for MPs too).
Those include the right to retire at 60 when everybody else soldiers
on to 65 (and many will work even longer to make up an inadequate
pension) and the entitlement to a pension worth an average 21 per
cent of final salary, compared with the average 7 per cent in the
private sector. The cost of these pensions is rocketing, from £2.3
billion last year to £3.8 billion next year.
So middle Britain has been doubly betrayed. First, all those stealth
taxes since 1997 didn't give us properly reformed public services.
Our schools still under-perform: expensive new buildings are no
substitute for tackling outdated working practices and LEA
bureaucracy. Classes are closed in term-time for staff training. My
local NHS Trust diverts cash from beds and drugs to employ a
"Director of Civic Engagement". Only half of Britain's fire engines
carry a defibrillator while half a billion pounds is wasted on
regional fire control centres, announced in 2000 but now not ready
until 2011.
But second, we're now told that all this isn't in fact sustainable.
In Monday's mini-budget we learnt that we must pay even more; in
fact, half of all taxpayers will have to pay more in two years' time
to bail out our bankrupt public finances. New Labour's contract with
middle Britain has been truly shattered. Hard-working families
struggling in a recession must pay higher National Insurance to fund
bureaucrats who can't be sacked, however inefficient, whose pay is
index-linked and whose pensions are worth three times as much as theirs.
In a little-noticed speech on the same day, David Cameron made the
moral case for ending what he called the "apartheid" in pensions. He
wants to close public sector final salary schemes to new entrants,
and to "discuss" further reforms by agreement.
Even public sector workers themselves see that this apartheid cannot
go on. This isn't an attack on public services. We need our nurses
and police officers (and they'll be paying more of Brown's taxes
too). But if the economy is shrinking, government can't go on
growing. Freezing civil service recruitment, scrapping expensive but
useless IT, cutting out regional bureaucracy, should be common ground.
But beyond better management of the public sector lies the deeper
issue of fairness. Three-quarters of taxpayers shouldn't cushion one
quarter. This is a moral argument: job protection, working practices,
pension rights - shouldn't these be equal for all our citizens ?
While the economy was growing and house prices rising, we didn't mind
what we couldn't see so clearly. Now that the music has stopped, MPs
can feel the rising tide of anger at the two Britains: the one
protected and unreformed; the other hammered and hammered, and paying
even more.
The middle classes in America found their voice in Barack Obama: he
promised change and a tax cut for hard-working families. Real reform
and fairness for all: isn't it time Conservatives promised One Nation
again?
-----------------------------------------------
Michael Fallon is Conservative MP for Sevenoaks
Posts
