Radical surgery still needed – and it will hurt

You should always play the ball not the man. Attacking Alistair Darling personally does not come easy, even for the most hardhearted commentators. He inherited a bad situation, particularly for the public finances, and it has got worse.

Few can have envied him his task over the past 22 months, which he has gone about with dignity and good grace. Few of us can imagine the intensity of the pressure he was under, particularly last autumn, and he deserves a lot of credit for his handling of the banking rescue.

There has to be a “but” to follow that and there is. I have sat through lots of budgets and last week’s ranks as one of the worst. It failed on four counts, and if there were more it would probably fail on them too.

It failed to do anything to instill the confidence Darling said was essential to recovery and which was billed beforehand as one of the budget’s aims. Most people and businesses will have felt less confident when he sat down than before he stood up.

It lacked a coherent theme. The hotch-potch of minor measures the chancellor announced looked like a random selection from a long list, because it was. Good budgets stay in the memory because they take a theme and run with it. This one did not, and if Darling was enthusiastic about the measures he announced, from car scrappage to wind farms to boosting capital allowances, he kept it hidden.

It further undermined confidence in politics. When, in November, he announced a new top tax rate of 45%, to take effect in April 2011, the chancellor could just about get away with saying he had not broken any manifesto pledges. Bringing forward that rise to April 2010 and increasing the top rate to 50% is a clear breach of Labour’s 2005 manifesto promise not to raise the basic or higher rates of tax. Unless, of course, Gordon Brown plans an election before April 2010.

The 50% top rate itself, apart from bucking the international trend and further undermining Britain’s tax competitiveness, has proved popular among people wanting revenge on bankers who earn more than £150,000. A little further thought will surely persuade those people that what is happening to the well-off now is bound to happen to them before too long. If ever a nasty post-election budget was on the horizon, last week set it up.

This is because the budget’s fourth failure was not putting an adequate plan in place to deal with the public finances. I am not particularly bothered whether public-sector debt rises to 80% of gross domestic product (GDP). I am concerned about how rapidly we get there and how dramatically the public finances have worsened.

Six months ago Darling unveiled a public borrowing projection of £118 billion for 2009-10, which most of us regarded as frighteningly bad; a few months before that a budget deficit of £50-60 billion would have been regarded as crisis territory.

Now we learn that we do not get borrowing down to £118 billion until 2012-13, after £175 billion this year, £173 billion in 2010-11 and £140 billion in 2011-12. All this assuming, of course, that the Treasury has now got to grips with the scale of the deterioration in the numbers.

The Treasury’s “illustrative path” tells us it will not have got the deficit down to acceptable levels — only borrowing to fund investment — until 2017-18, by which time Brown will be drawing his state pension.

The problem with the public finances is not the easy hit that most economists and commentators have latched on to. For the purposes of the public finances, the Treasury has assumed the economy recovers by 1.75% in 2010-11 and then grows by 3.25% annually for the three years after that.

Forecasters have queued up to dismiss this as wishful thinking, because it is hard to envisage any growth, let alone more than 3%, in the depths of a recession, particularly after a 1.9% first-quarter GDP slide.

Something like this, however, usually happens after recessions. Ken Clarke, who dismissed the Treasury’s numbers last week, presided over something very similar when he was chancellor, against a backdrop of rising taxes and an “eye-wateringly tight” squeeze on public finances.

Average growth over the four years from 1993 to 1997, after the last recession, was 3.1%. In the early 1980s (1982-86) it was just over 3%. Even in the turbulent 1970s, the bounce from the 1974-75 recession saw four years of 2.7% growth.

Things may be different this time, not because of the reduced role of financial services, which were only ever 8% of GDP. Research suggests that recoveries from recessions generated by financial crises are more subdued than normal.

Even here, however, the evidence is far from conclusive. Britain’s economy romped ahead when recovering from the worst of the slide of the Depression years, growing nearly 5% a year for three years from 1933 through 1935.

No, the problem is more fundamental. It is what the Treasury fears will be long-term weakness of tax revenues even when growth resumes. It may have overstated it but the scary thing about the public finances is how much of the deterioration it sees as structural, or permanent.

Of this year’s borrowing of 12.4% of GDP — yes 12.4% — 9.8% is reckoned by the Treasury to be structural and even after the budget and pre-budget report measures have been implemented, Britain will still have a structural deficit of 4.5% of GDP in 2013-14, when the parties will be gearing up for the election after next.

The excellent Institute for Fiscal Studies, which warned of some of the horrors the chancellor was set to unveil, says the measures detailed so far leave about half the surgery that will be needed on the public finances, some £45 billion in annual tax increases and spending cuts, as mere Treasury aspiration, to be implemented some time between 2014 and 2018.

That is too long to wait. Radical surgery will be needed on the public finances, and it will have to come sooner than that. As it is, Darling has put in place plans that imply total government spending drops by 0.1% a year in real terms for the three years from 2011, after growth of more than 4% since 1999. For the public sector, and regrettably for taxpayers, it is going to hurt.

PS: The budget, intended by Labour to be a trap for George Osborne — increase the top rate of tax and dare him to oppose it — could turn into a great opportunity. I have been critical of the shadow chancellor in the past, reflecting the doubts I hear expressed from business people.

Osborne cannot do much about his youth and inexperience. What he can do is seize the crisis over the public finances by the scruff of the neck and demonstrate that he has a plan to solve it. This means abandoning the political convention of only partly showing your hand on tax and spending just ahead of an election and then revealing the full deck in the emergency budget that follows it.

People know instinctively that borrowing at the levels set out by Darling is not sustainable. Just as in the late 1970s voters knew unions had to be curbed, and welcomed Margaret Thatcher, so they now know the public sector has to be shrunk to a level the country can afford. Osborne’s mission over the next 12 months should be to set out details of how a future Tory government would achieve that. Leaving it until the election campaign will be too late.

Party strategists might say David Cameron did not get this far to fall at the last hurdle because voters think his party are unreconstructed spending slashers. But the game has changed. The Tories lost elections when people had a warm glow about apparently affordable increases in spending. They do not any more.

The shadow chancellor’s advisers point to groundwork he has laid in preparing people for a different era of public spending and exploring the processes to more tightly control it. Next will come detail on areas from which government will have to withdraw to slim down the state. It sounds promising.

From The Sunday Times, April 26 2009

Originally published at About David Smith’s EconomicsUK.com and reproduced here with the author’s permission.

One Response to "Radical surgery still needed – and it will hurt"

  1. ashura   May 1, 2009 at 10:37 am

    And how utterly ridiculous that we should be left the Hobson’s choice of voting only for people who set political traps for each other, whether or not it is good for the nation as a whole (which it invariably isn’t). The problem lies with the system, which encourages both short-termism and political swingball. Most Western (so-called) democracies are run by little boys in big grey suits. And we lambast countries like China for its centralism.