Wednesday, October 01, 2003
Gordon Brown confronts his borrowing problem
Posted by David Smith at 09:26 PM
Category: David Smith' s magazine articles

Almost a year ago, in November 2002, Gordon Brown experienced the worst time, and the worst headlines, since becoming chancellor of the exchequer in May 1997. After five years in which the iron chancellor had kept a vice-like grip on the public finances, the autumn of 2002 saw a big change.

Until then, Brown had always managed to come in even below his own tight forecasts for borrowing. The public finances, were often in surplus and debt being repaid, even without such helpful windfalls as the 22.5 billion auction of third generation mobile phone licences.

The chancellor and his Treasury team wore their prudence with pride. This was a different kind of Labour government, one that made room for extra spending in priority areas but only after sorting out the books first. Previous Labour administrations had spent first and picked up the pieces later. Under Brown, prudence produced a win-win situation. Reducing government debt, for one thing, cut debt interest payments, and the money could instead be channelled into health and education.

So when, in his pre-budget report, the chancellor unveiled big increases in government borrowing - 20 billion for 2002-3 and 24.5 billion for 2003-4 – it was a highly significant event. For both years the new borrowing projections were about twice what the chancellor had forecast the previous spring.

The indignities were many. On the day after the pre-budget report the headlines read “Goodbye Prudence” and the commentators asked whether this Labour chancellor was going the way of his predecessors. His early prudence may have delayed the consequences of tax and spend (particularly spend) but they were now coming through with a vengeance. Brown was prepared for a poor reception but still winced at the blows.

The Treasury, of course, denied any loss of control over the public finances. The world economy was emerging only slowly from recession and in every country the public finances were coming under pressure. But it made no sense at all to try to tighten fiscal policy by cutting spending or raising taxes further during a period of economic weakness (less pronounced in Britain than in other countries). The “new prudence” was to allow the automatic stabilisers to operate by borrowing more at a time of below-trend growth.

Brown and his advisers also insisted that there was no question of the government failing to meet its fiscal rules – the “golden” rule of borrowing over the economic cycle only to fund investment, and the sustainable investment rule, of keeping government debt below 40% of gross domestic product.

There was even a hint that the borrowing forecasts may have been deliberately over-egged. 20 billion was more than independent forecasters had been predicting at the time and the chancellor had a history of coming in on the right side of his fiscal numbers.

A year on, and the latter point can safely be laid to rest. Borrowing in 2002-3 was 22.2 billion, and thus above the 20 billion forecast, and there was worse to come. In his April budget this year, the chancellor was forced to revise up his 2003-4 borrowing projection up to 27 billion, followed by a slight drop to 24 billion in 2004-5.

Now, as Brown prepares to step up to the plate to deliver his 2003 pre-budget report, he faces an unpalatable choice. He could stick to the borrowing projections he made in April, in which case nobody would believe him. Or he could revise them up again, and accept another batch of humiliating headlines. The only comfort is that this being economics, the law of diminishing returns probably applies. This year’s headlines, in other words, will not be quite as bad as last year’s.

The chancellor’s problem is that the numbers are going against him. With figures in for nearly half of the 2003-4 fiscal year, tax revenues are running below the Treasury’s forecasts, while government spending is coming through much faster. Current spending by government is up 9 per cent, the Institute for Fiscal Studies says, against a projected 6.5 per cent. Capital spending is up by a massive 175 per cent, which could be great news for the infrastructure but does not help a chancellor watching his budget deficit grow wider by the day.

Independent economists surveyed by the Treasury expect, on average, borrowing of 31 billion this year, 2003-4, and 34 billion next - 4 billion and 10 billion above the Treasury’s projections. More worryingly, unlike the Treasury, they do not expect borrowing to come down from that 30-40 billion level in subsequent years. The National Institute of Economic and Social Research says Brown has only a 50-50 chance of achieving his golden rule. Since that rule has been presented as sacrosanct, the potential for further serious damage to the chancellor’s reputation is large.

The borrowing problem has three sources. The economy, while avoiding recession, has been growing below trend, and this has naturally pushed up borrowing. With optimism increasing, that factor should diminish in importance.

Second, tax revenues have been weak, even in relation to the sub-trend growth. Corporate tax revenues, in particular, have been well below what the Treasury expected. The danger here is a repeat of the first half of the 1990s, when for several years economic recovery did not produce the revenue boost the then Conservative government was relying on.

Third, public spending appears to be obeying the old rule that once let off the leash it becomes impossible to keep under control. It took time on this occasion for spending to get going. Now it has, it looks unstoppable.

The Treasury is trying to act on that. Paul Boateng, the chief secretary, has warned Whitehall departments to expect tough times ahead. Initial sparring has begun for the 2004 comprehensive spending review and he has circulated a letter to cabinet ministers warnings them that from 2005-6 “most departments should assume that they will receive no more than flat real increases in their overall budgets, some departments may receive less.”

Bringing spending back under control will not be easy, and by the time it is plenty more big borrowing numbers will have flowed under the bridge. The chancellor has insisted he will not break his own rules. The alternative course, as businesses will be well aware, will be another round of tax increases. We have not reached that point yet but it may not be too far away.

From Business Voice, October 2003