Sunday, November 23, 2008
Darling risks drowning in a sea of red ink
Posted by David Smith at 12:09 AM
Category: David Smith's other articles


Say what you like about Alistair Darling but his pre-budget reports are must-see events. A year ago he tried to put the ducks in place for the election that never was with eye-catching announcements, some stolen from the Tories. How long ago that seems.

This time the run-up to the PBR has provoked intense debate about economic policy and elevated tomorrow’s statement to something extraordinarily important, economically and politically.

On one side of the policy divide you have Gordon Brown, flush with something approaching international adulation, not entirely justified, because of Britain’s banking rescue.

Last weekend’s G20 meeting in Washington gave him what he wanted. Not an agreement on a co-ordinated global package of tax cuts and increases in public spending but an acceptance that fiscal activism, where appropriate, made sense.

Brown was keen on this outcome, because it gave him political cover and because fiscal activism is more effective if many countries do it, reducing the danger that measures adopted in Britain would simply benefit other countries’ exporters.

Then we have the Treasury. A few weeks ago, even in the context of this autumn’s financial crisis and banking rescue, the word from officials was that monetary policy — interest rate cuts — should carry the weight of getting the economy out of recession. Treasury officials know they will be left with the job of clearing up afterwards and Darling did not want to go down in history as the man who presided over mind-boggling levels of borrowing.

Last week’s figures, showing £37 billion of such borrowing in the first seven months of this fiscal year suggest he would have been hard pressed to come up with a 2008-9 number much below £65 billion- £70 billion, even without additional measures this week. The numbers for 2009-10 were scarier, even before the stimulus.

Oil revenues, one source of comfort, have joined the downward trend, along with the corporate and personal tax take. Treasury officials knew they were looking at the first three-figure borrowing total in history — as in £100 billion-plus.

But words have been said and compromises reached. Tomorrow it will be hard to put a cigarette paper between Brown and Darling.

The big difference is between Labour and the Tories. In one respect, David Cameron has made a political error in recent days — he has sowed confusion. Few people have a clear idea of what the party’s policy is at the moment. I hope I have.

There are two elements. The recession-fighting element was “funded” by tax changes, such as a National Insurance holiday for firms taking on new workers from among the unemployed and a two-year council-tax freeze. But, crucially, if you believe the party’s costings, there would be no net giveaway.

The second element is Cameron’s new policy of not matching Labour spending commitments from 2010-11 onwards. This, a post-recession policy, anticipates what is likely to be a downward revision to medium-term spending projections by Darling (though starting later than 2010). It also makes the sensible point that there are ways of reining back the budget deficit in future other than pushing up taxes.

The reason the Tories have had problems is not just confusion. They are on the wrong side of a debate in which almost everybody, including the International Monetary Fund and Bank of England, thinks a fiscal stimulus is necessary. Business organisations, including the Institute of Directors with its call for a £20 billion stimulus, and the Engineering Employers’ Federation, which today calls for £30 billion, think the Tories have got it wrong.

But a consensus can be mistaken. Could the Tories have got it right? Nobody remembers better the long hangover from the recession of the early 1990s when, due to the Major government’s attempt to spend its way out of it, years of tax increases and tight public-spending constraints were needed. While the recession ended in 1992, its legacy persisted to the end of the 1990s, when infrastructure spending fell to its lowest level sice 1945.

Whether the Tories have got it right now depends what kind of recession we are in. If we are facing a short “V” shaped recession, of the kind the Bank predicted earlier this month (without assuming any fiscal stimulus), the sensible strategy for the Treasury would be to do as little in net terms as possible.

The trouble is, nobody can be sure, despite the fact that, thanks to very low interest rates and sterling’s fall, the economy is benefiting from a huge monetary stimulus. Contrast 3% Bank rate and a low pound now with a 15% rate and an overvalued sterling at the beginning of the 1990s.

So the argument for a fiscal stimulus is based on fear of something longer and deeper, akin to Japan during its “lost” decade. We do not know how big a danger this is — which is why a fiscal boost looks compelling. The fact that the banking system remains so fragile, and may not withstand a long, deep recession, adds further weight, however much the idea of the government increasing debt sticks in the craw.

For Brown there is a double advantage. If the economy pulls out of recession quickly he will be able to say it is due to the actions he took that the Tories opposed. If it does not, he will be able to claim he did everything possible to prevent it.

One thing we will get tomorrow is a plan for sorting out the public finances once the recession is over. Whether or not it is a credible plan remains to be seen.

John Hawksworth of Price Waterhouse Coopers suggests it will have to include two key elements — a stress that the tax cuts are temporary in nature and will be reversed, and a real freeze on government spending from 2011 onwards. That would allow the government’s “structural” budget deficit — as distinct from the effects of the economic cycle — to come down from a peak of more than 4% of gross domestic product to just over 1%.

As Hawksworth suggests, any plan would be more credible if it were independently policed. Keynes is much in vogue these days and we all know what he said about the long run. In the long run, one way or another, we will all have to pay for tomorrow’s announcements.

PS: The causes of recession may be different but echoes of the early 1990s are powerful. The banks’ treatment of small firms is following a very similar pattern. Then, banks faced a government investigation which resulted in a code of conduct for small-business lending, though only after the damage had been done.

Now they are under direct pressure from politicians to change their behaviour. The government has additional leverage, thanks to the banking rescue, and we will hear something tomorrow about how it aims to improve matters, mainly through pumping more into the Small Firms Loan Guarantee scheme but also with the threat of more direct action.

Improving things will be an uphill task. Eighteen months ago the word from bank head offices to regional managers was lend to increase market share. Now it is rein back hard on lending to save the bank and your job. Like the early 1990s, but a more extreme version.

Finally, last week’s competition. The challenge was to list the past seven chancellors in order, best to worst, with a tiebreaking justification for choice of champion or dud. The seven are Howe, Lawson, Major, Lamont, Clarke, Brown and Darling. The huge response warrants a league table. I’ll let it run until close of play Wednesday. Results next Sunday.

From The Sunday Times, November 23 2008