Sunday, September 30, 2007
Darling gets ready for the big squeeze
Posted by David Smith at 10:00 AM
Category: David Smith's other articles

darling.jpg

Is it safe to write about something other than the credit crisis and Northern Rock? Maybe not, particularly after Richard Lambert, director-general of the CBI, likened the “almost unimaginable” run on Northern Rock as the thing you would expect in a banana republic. But let me risk it.

Life goes on, and at the Treasury’s swish headquarters overlooking St James’s Park they are gearing up for Alistair Darling’s big announcement.

While some details have yet to be finalised, officials are pretty well ready for Darling’s “super Wednesday”, when both the three-year comprehensive spending review (CSR) and the prebudget report (PBR) will be published. The favoured date is October 17, although, pending Gordon Brown’s deliberations on election timing, it could come a week earlier, on October 10.

The PBR will include a new economic forecast. Independent forecasters have been slashing their numbers and the consensus is coming down to 2% growth next year. The Treasury had 2.5% to 3% as its 2008 forecast in the March budget. It may feel vindicated by getting it right this year and stick with that. Some officials believe there is not enough evidence of an effect from the credit crisis to justify a change.

The PBR will also be watched for action on the tax treatment of private equity, having “on the record” ruled out a knee-jerk response. There will be eyecatching proposals on the tax treatment of cars – designed to provide a clear price signal in favour of less-polluting vehicles – which will grab the headlines.

On this occasion, however, the more important announcement will be the spending review. We have not had one of these since 2004, Brown postponing the one due last year until Tony Blair was safely out of the way.

The 2007 CSR will be a programme for a 10-year Brown government – I do not blame you if your heart sinks at that prospect – to “deliver the investment and reforms to equip the UK to prosper in the decade ahead”.

The meat of the CSR will, however, be decisions for the next three years, 2008-9 to 2010-11. After the feast of recent years they will mark a return, not to famine, but certainly tighter rations.

The budget deficit remains stubbornly high; figures last week showed record government borrowing for any August. As the OECD put it last week: “There is a need to further reduce the government deficit, which will require much slower growth in government expenditure . . . and more effort devoted to ensuring that publicly funded services provide good value for money.”

How tough will it be? Carl Emmerson at the Institute for Fiscal Studies has been crunching the numbers. The “envelope” for spending for the three years allows for 2% real-terms growth annually, split between a 1.9% rise in current spending – wages and salaries, medicines, running costs, etc. – and 3.2% a year in capital spending.

Setting that in context, if we leave aside Brown’s first two years at the Treasury – his “hairshirt period” when spending fell 0.2% annually in real terms – there will be a sharp slowdown compared with the years of plenty.

Since spring 1999, spending has grown by an average of 4% a year in real terms. So for the next three years, the public sector will have to make do with half those increases. The slowdown in capital spending will be even more abrupt. It has grown by an average of 15.4% a year since 1999 and will now see rises of just a fifth of that.

Even more challenging is how to slice the spending pie. The Treasury has said education will rise by 2.4% a year (implying a decline in its share of GDP) and defence by 1.5% annually. The Home Office and some smaller departments have agreed cuts. The hard one is the NHS, given priority status by Brown at the Labour party conference last week.

If the NHS gets 4.4% a year, in line with the recommendations of the 2002 Wanless review, that would leave increases of only 0.1% a year for those departments that have not settled, or for whom there are no solid commitments (a generous rise in the overseas aid budget has been committed). If the NHS is allowed 3.4%, that would leave 0.9% annually for those other parts of government. Either would represent an exceptionally tough settlement, particularly after the splurge. They would also mean further tension between ministers and public-sector unions.

The Darling-Brown squeeze – a gift from the former chancellor to the current one – means public spending will be rising at a slightly slower rate of growth than the economy as a whole, which the Treasury expects to be 2.5% a year over the 2008-11 period.

What will the impact be on the economy? There is a widespread perception that most new jobs in Britain in recent years were in the public sector. That is wrong. Between 1998 and 2005 public-sector employment rose 680,000, compared with 1.28m for private-sector workers. Conspiracy theorists will note public-sector employment peaked in mid2005, the time of the last election, since when it has fallen by 78,000.

On a longer-term view, public-sector employment fell by 816,000 between 1991 and 1998, before rising, then more recently falling, under Labour. At just under 5.8m, the number of public-sector workers is smaller than it was in the early 1990s.

Despite this, there will be an impact from slower growth in public spending. The splurge had a big impact, particularly on those parts of the country that have become worryingly dependent on the public sector. For them it will feel like cold turkey. Calculations by the Centre for Economics and Business Research, based on Treasury figures, show a public-spending-to-GDP ratio of over 70% in Northern Ireland, 64% in Wales, 63% in the northeast and 54% in the northwest.

Combine the necessary slowdown in public spending with the weaker outlook for consumer spending and the economy looks to have lost two of the strong drivers of demand in recent years. It will look rather grey, if not grim. No wonder Brown has been reaching back into his father’s sermons for guidance on when to call the election.

PS I haven’t mentioned my skip index for a while but perhaps I should now. Long-time readers will know that the index is based on the number of builders’ skips in my street – two is normal, four a boom, and none at all means we’re in trouble. After a healthy summer for skips, a few days ago they all went away, vanishing with the autumn chill, before a couple reappeared. Should we be worried? I’ll report back in a couple of weeks.

I don’t know whether the index featured in Friday’s run-through of the data by the Bank of England’s monetary policy committee (MPC), but its decision this week looks fairly straightforward. Most of the more conventional economic numbers are strong; the fact that nobody drew on its £10 billion liquidity facility was a positive, and there is no reason to rush to a judgment on interest rates.

That is the view of most members of the “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs. One, Patrick Minford, thinks the Bank should boldly go in the Federal Reserve’s direction by cutting interest rates by half a point to 5.25% this week, to get monetary policy back on its precrisis course. He also thinks the “bias” should be for further rate cuts to offset economic weakness.

All eight other members opt to hold rates, but have different views on what should happen in the coming months. Ruth Lea of the Centre for Policy Studies, Peter Warburton of Economic Perspectives and Trevor Williams of Lloyds TSB all think the bias should be towards future cuts, while David B Smith of Beacon Economic Forecasting and Andrew Lilico of Europe Economics believe that when the dust settles the Bank may yet have to hike further. The others are neutral. All should become a little clearer in November.

From The Sunday Times, September 30 2007

Comments

David,

Is it just me or am I the only cynic that thinks Alistair D. on strict instructions of Gordon B. , only reffered to the £100K figure for investor protection whilst the queus were outside Northern Rock branches?

Someone I think referred on your site to inflation getting out of control but it didn't go down too well. I wonder if the scenes are to be repeated.....

Posted by: F.Fox at October 1, 2007 05:49 PM

That wasn't quite the sequence. Darling announced an unlimited but temporary guarantee when the queues were still there, then a few days later - the following Saturday morning - floated the £100,000 figure, by which time the queues had gone. But I was surprised that we got the announcement only of £35,000 (100% backed) today. In interviews, he has said he wants to go further, but there was no such commitment in the speech, and no mention of £100,000:
http://www.hm-treasury.gov.uk/newsroom_and_speeches/speeches/chancellorexchequer/speech_chx_011007.cfm

Whether we get more bank runs or have to wait another 150 years is an interesting question but I don't think it'll be because we have a bout of hyperinflation.

Posted by: David Smith at October 1, 2007 05:59 PM
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