ANALYSIS & OPINION
From the desk of MD
TODAY’S UK BUDGET offered a glimpse of the type of state fiscal discipline that will be required for the next twenty years. The deficits revealed, today, under Alistair Darling’s Budget, cannot be brought back under control even in the life of the next parliament; it will take at least two, to bring borrowing back to a sustainable level. What is certain is that for a decade, maybe even a generation, government spending will be constrained and taxes seem certain to be higher than they are now.
For the Prime Minister, Gordon Brown, the 2009 Budget is a catastrophe because it has swept away everything he stood for. Simply contrasting what has been disclosed today with key passages made by Mr. Brown in his Budget speech of 9 March 1999 makes this clear. Then, Gordon Brown said that the budget would be in surplus. His prediction was that the forecast surplus be around £4 billion, with the public sector net borrowing in the black by £1 billion. That seemed impressive given the £28 billion deficit Labour had inherited. Continuing on the theme of “good housekeeping”, Brown stated, then:
… I am determined to continue locking in this fiscal tightening for the years to come so that we continue to meet our fiscal rules and so deliver sound public finances.
… In line with our golden rule, even under our most cautious assumptions, we are balancing the current Budget over the economic cycle. And for the first time in a generation we are eliminating the current structural deficit. We are also meeting the second fiscal rule, that of sustainable investment, a prudent ratio of debt to national income.
A decade in politics is a long-time. Crucially, however, it will be down to the next government to start the process of fiscal discipline and how that might be established for the long term.
Yet, we should remember that this economic maelstrom is not merely just a British problem. To see things only through the Westminster prism would be blinkered, and easy to blame the government currently holding office. The Conservative Party principles of free markets are as much to blame as the poor management exercised by the financial regulatory authorities. Whilst no-one is dismissing the fact that Britain has had a failure of both economic policy and financial control, and our living standards are likely to deteriorate further in the coming months, every other country in the world – as the Prime Minister rightly highlights – also has unsustainable finances. That is not a consolation by any means, but certainly relevant as countries desperately attempt to address the plunging deficits they are faced with. 2009 could well come to be seen as an historic point for public policy, not just in the UK, but throughout the developed world.
ANALYSTS WILL UNDERSTAND there are several ways of gaining some perspective on the overall picture. One way is to look at public finances this coming cycle. The UK looks set to move from a national debt of 40% of GDP to one that is between 80 and 100%. Because of this the price of combating a recession, however bleak, will in all likelihood be less serious than that that of the early 1980s, through doubling of the national debt. Worryingly, though, is that when the next downturn comes, in say 2018, the UK will still be paying off the cost of the present one.
Will that be true for all other developed countries? The answer is probably yes. We did at least start with a relatively low public deficit. Other countries will also find they have deficits quite close to 100% of GDP: they may have smaller running deficits in comparison to the UK but most started from a higher base. Japan’s deficit is converging towards 200% of GDP and has reached the point where further borrowing can have no effect on demand. In Japan the reverse is probably true because when deficits are so high the more people are likely to save for the future.
Another way of looking at these public deficits is to see them in terms of inter-generational equity. For example, to what extent should people now load the cost of our pensions or financing of public services on to the next generation of taxpayers? Or, in other words frontloading present costs onto our children. Demographic trends, though, suggest that this is an untenable option: there will be fewer children relative to the number of workers and the workforce is already starting to contract. Correspondingly, the number of pensioners is also on the increase. The combination, then, of fewer workers, with more pensioners and a much larger national debt is a toxic one, all the more so it is predictable and a known certainty. The toxic debts accumulated by the world’s banking system were, of course, less known.
But, whatever has sprung from today’s budget – including the 50% higher tax band to be imposed on earners over £150,000 p.a. – it seems inevitable that our children will pay much more tax than they receive in social benefits.
The demographic argument was offered by Hamish McRae of the Independent Newspaper who suggests that, when governments ran up huge deficits in the past it was to fight wars, a price that most of us would accept as being worthwhile in defending the country during the Second World War. Now, the deficits are being incurred so that more can be spent on social benefits than people are prepared to pay in taxes. Our children, he says, will have a right to feel cheated.
Image Credit: Economist, 22 April 2009 -- Britain's economy has been savaged by the downturn, but it could be worse?
To see the parallel with the 1970s is another way of looking at the present crisis. Then, the developed world faced a monetary crisis; now it is fiscal. In the 1950s and 60s reduced demand led to higher unemployment, which was met with monetary policy instruments. Progressive economic cycles witnessed slightly higher unemployment and slight inflationary pressures (the general price of goods). Global prices remained under reasonable control, pegged in part to the falling cost of energy. Inflation soared in the 1970s when OPEC announced its soaring prices.
During the surge in oil prices of the 1970s the UK had a particularly bad time of it. The annual increase in the Retail Price Index (RPI) reached more than 20%, and the social unrest that stemmed directly from surging inflation culminated in the so-called “winter of discontent” (1978-79). Incidentally, the RPI for February 2009 was given as 0% and is likley to fall to -3 % by September, 2009.
After some painstaking effort, inflation was eventually brought under control but it took the better part of two decades to do so. The misery of the recessions of the 1970s, 1980s and 1990s did follow which led to the destruction of industries, many in Scotland, whose costs were out of line to a Westminster agenda. The result was mass upheaval with many people losing their jobs who never found work again. The Thatcher government is largely held responsible for the economic demise that followed in Scotland, and will never be forgotten.
ONE of Gordon Brown’s first acts as Chancellor of the Exchequer, which was a major milestone, was granting independence to the Bank of England. The independence of the Bank of England has been crucially important because it has major influence in how inflation is managed, along with the setting of interest rates. During the 1970s, inflation – and the subsequent squeezes it inflicted – distributed its pain in a random and inequitable fashion.
Is it 1976 all over again? Strictly speaking, maybe not. Commentators such as George Soros, who commented in the Times, recently, expects that even Britain may have to go pleading to the International Monetary Fund (IMF) for a bail-out loan given its soaring obligations to the British taxpayer after having bailed out many high street banks after the near collapse of financial markets at the end of 2008. Many other analysts, too, are not strictly ruling out that option, either. However, what is certain is that many countries, not just Britain, will have to spend the next 20-25 years figuring out how to impose fiscal discipline on governments, a similar timescale that it took to impose monetary discipline.
Mr. McRae rightly argues that there is no simple magic wand, or no right way of correcting what has become the profound weakness of Western democracy. Elected governments, he says, have to retain ultimate authority for fiscal policy, whereas control over monetary policy can, if the need be, be distanced from politics. The failings of the “golden rule” under Mr. Brown’s stewardship, though, and of the Maastricht Treaty aren’t incidences that should be forgotten too quickly just because we are faced with a “global crisis”. The failings of the golden rule, and how the parameters were moved by Gordon Brown, could yet come to haunt Labour as the UK enters a critical period before the General Election.
BUDGET MEASURES
Chancellor Alistair Darling today gambled on a rapid economic recovery to rebuild Britain’s battered finances as he revealed that borrowing this year would hit a record £175 billion.
In a dour Budget statement he outlined the full depth of the economic crisis.
Mr Darling warned that output would shrink by 3.5 % this year – more than doubling his previous forecast.
And, he revealed that borrowing this year would soar to £175 billion – with another £173 billion in 2010 – as the country battled with the worst global downturn since the Second World War.
He also said deflation would plunge to - 3% by September.
Despite the bleak figures, Mr Darling insisted public finances would get back on track with a halving of borrowing within four years as the economy began to recover from the end of the year.
The Chancellor made clear that his plans depended on a rapid economic bounce-back – with a forecast of 1.25 % growth next year rising to 3.5 % in 2011.
Nevertheless, he admitted that the economy would first face of a period of deepening deflation with the Retail Price Index falling to a low of - 3 % by September.
The Chancellor warned that rebuilding the public finances would take “tough decisions”
He said the planned new top income tax rate of 45 per cent on incomes above £150,000 will be increased to 50 per cent and take effect from next April – a year earlier than planned.
And from April 2011, pension tax relief would be restricted for those with incomes over £150,000.
Mr Darling defied calls from transport and motoring groups for another freeze on fuel duty which will rise by 2p a litre in September and then by 1p a litre above inflation each April for the next four years.
But he confirmed the Government would attempt to kick-start the ailing motor industry by introducing a car-scrappage scheme.
Anyone with a car registered before 31 July 1999 will get a cash incentive of £2,000 to trade in their old vehicle for a brand new one.
A total of £1,000 will come from the Government and the remaining £1,000 from car companies, with participants being able to buy any new vehicle, including small vans, rather than just low-pollution models.
Around £300 million has been put aside by the Government to fund the scheme which is expected to come into effect as early as mid-May and will last until the grant runs out, thus enabling 300,000 consumers to benefit.
Drinkers and smokers will be hit with alcohol duties to go up by 2 % from midnight tonight, while there will be an increase in tobacco duty of 2 % from 6pm tonight.
© Mark Dowe 2009: all rights protected
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Filed under: Economic | Tagged: alistair darling, Bank of England, Banking, budget 2009, budget deficit, central bank, demography, economic downturns, economic recession, financial market regulation, fiscal and monetary policy, general el, george soros, global financial crisis, global recession, golden rules, gordon brown, government borrowing, great depression, hamish mcrae, IMF, IMF loans, inflation, interest rates, japan, national debt, opec, public finances, public policy, RPI, Scotland, social benefits, taxation, thatcher, unemployment, winter of discontent
