Britannia Radio

"outright fiscal catastrophe only a matter of a year or two off" - - unless

This article by Jeremy Warner represents a remarkably swift learning curve. When he arrived at the Telegraph from the Independent not many weeks ago he was cautiously optimistic. Now hed too sees apocalypse around the corner and no comfortable and easy way out.

To all those readers who are still dreaming of a priority for referendums I can only say - - “Do get real” . This is the future of politics not constitution building here or in the EU, much less meaningless referendum about something that's over!

In passing I would mention that the redoubtable Ambrose Evans-Pritchard in yesterday’s (9/11/09) paper was - only pafrtly in jest - saying investors should perhaps be looking to zimbabwe for opportunities for that country has touched the bottom and is on the way up again - and, unlike Britain, it has stopped printing money. “For brave investors, Zimbabwe could be the ultimate turnaround”

Christina

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TELEGRAPH 10.11.09

Britain's public sector faces the Geddes axe

As Alistair Darling, Britain’s Chancellor, pores over the numbers in preparation for the forthcoming Pre-Budget Report – expected late this month or early next – you have to wonder how he manages to sleep at night.

By Jeremy Warner

The state of Britain’s public finances is enough to make even the most optimistic of policy makers despair. The size of Britain’s national debt seems to be almost hopelessly out of control, with outright fiscal catastrophe only a matter of a year or two off without swingeing cuts well beyond anything currently contemplated.

In all likelihood, it will be someone else’s problem in little more than six months time but Mr Darling is tougher than he seems and he hasn’t given up yet. To head off the very real possibility of an economically crippling sterling crisis going into the election, he has to come up with a credible long term plan for digging the nation’s finances out of the mire.

In the 1920s, a massive reversal in public spending growth was achieved under a draconian programme of cuts known as the “Geddes Axe”. The “Geddes committee”, appointed by David Lloyd George’s Liberal coalition Government to improve on the Treasury’s supposed feebleness in identifying savings, succeeded in reducing public spending by 25pc, or roughly £100bn in today’s money. One in three public sector jobs was culled.

None of the main political parties envisage anything so extreme this time around but the way things are going, it may come to that. Two reports over the past week have added to the sense of alarm. In an analysis for EU finance ministers, the European Commission warns that even assuming growth returns to pre-crisis levels, the gross national debt to GDP ratio for the European Union as a whole could reach 100pc as early as 2014 and then carry on growing. A similar conclusion is reached by the International Monetary Fund in its latest “cross country fiscal monitor”.

With its old fiscal rules in tatters, the UK Government has taken instead to committing itself to halving the deficit in four years. The Pre-Budget Report will further seek to reassure markets with a Fiscal Responsibility Act which will enshrine deficit reduction targets in law.

Yet, absent of a miraculous rebound in the economy, it’s unlikely to be enough. The only reason markets haven’t been harsher already is that we are in a kind of phoney war, where some softness in approach is temporarily tolerated because of the severity of the recession and, bluntly, because in the run up to an election it is assumed politicians will lie to the voters over the scale of the austerity that has to be imposed.

Once the election is out of the way, the markets will demand more realism. It is assumed, possibly wrongly, that the advanced economies have a plan for debt reduction which will fast be implemented once the worst of the recession is over. But time is running out. If these strategies are not divulged soon, then the confidence of markets will wane.

The IMF reckons that as a rule of thumb, every one percentage point addition to the fiscal deficit will add 10 to 60 basis points to long term interest rates. Rates would also rise 5 basis points for every 1pc of GDP increase in the national debt.

Using even the UK Treasury’s more modest forecast of the growth in national debt up to 2014, the effect would be to add around two percentage points to long-term interest rates. Just removing the discretionary stimulus won’t be enough. For all advanced nations, government debt would still be on an explosive course.

Getting the money back from financial system support will help but it doesn’t offer anywhere near a complete solution, nor will merely stabilising debt at post crisis levels be sufficient. High levels of debt would eventually entrench higher real interest rates. The chances of a debt trap, where governments have to borrow more just to service existing debt, are all too apparent.

So what sort of a consolidation needs to be done? Using the IMF calculations and assumptions, bringing the debt to GDP ratios of advanced economies down to below a target level of 60pc by 2030 will require reversing structural deficits of an average 3.5pc in 2010 to a surplus of 4.5pc by 2020 and then keeping it there until 2030.

The challenge for Britain is even more extreme. Undue reliance for tax revenues on the bubble sectors of financial services and housing in combination with unsustainably high levels of growth in public spending has resulted in a bigger structural deficit than anywhere else in the advanced world. The fiscal adjustment to bring debt down to pre-crisis levels is therefore correspondingly larger – a massive 12.8pc swing from fiscal deficit to surplus, against an average of just 8pc.

Some of this adjustment is already built into the UK Treasury’s published plans for the next four years. The IMF is also a good deal more pessimistic about growth prospects than the UK Treasury, as well as the mix of that growth and therefore its consequent tax yield.

In any case, projections spanning more than 20 years might reasonably be viewed as meaningless. Nobody knows what’s going to happen over such a time frame. It’s just extrapolation.

Even so, to manage the debt crisis effectively policymakers have to command the confidence of markets and for that they need to put in place a credible path back to a sustainable fiscal position.

Whatever reasonable set of parameters and assumptions you use, the scale of the fiscal challenge still looks formidable. Something similar to the Geddes committee may eventually be required to push through the necessary cuts. Simply axing public sector workers, or outsourcing their jobs, won’t be enough this time. The heavy lifting will have to be done through reductions in benefit entitlements, including pensions and health.

The bad news for David Cameron as he prepares to march into Downing Street is that governments that impose austerity don’t tend to last very long.

Labour’s post war period of austerity brought eventual electoral disaster, as did the austerity package imposed, in part at the insistence of the IMF, under the Callaghan government of the late 1970s. Mrs Thatcher only survived the recession and accompanying fiscal consolidation of the early 1980s thanks to the fortuitous intervention of the Falklands war.

George Osborne, the shadow Chancellor, has derided Treasury forecasts of a “trampoline” like bounce back to above trend growth in the economy, and maybe he’s right in thinking them delusional. But this is in fact his best hope of political longevity. It may be the right thing for the economy, but the voters aren’t going to thank him for imposing a Geddes Axe.