Monday, November 24, 2008
The longest hangover
Posted by David Smith at 06:00 PM
Category: Thoughts and responses

Alistair-Darling-delivers-001.jpg

There are many stories in today’s pre-budget report but let me, as an initial reaction, concentrate on just two. The first is the deterioriation in the public finances and the second is the impact of Alistair Darling’s discretionary action, both in the short and medium-term.

The most striking number in the pre-budget report is for next year’s public sector net borrowing. In March the Treasury expected £38 billion of borrowing for 2009-10; now it expects £118 billion, more than three times the level.

An upward revision of £80 billion in the space of eight months is going some, even after everything that has happened in the past few months, and even taking into account the Treasury’s shaky forecasting record in this area.

That number was, at least, in the market. The figures for future years will, if anything, have come as a bigger shock. After £77.6 billion this year and that £118 billion next, the numbers for the following three years are £105 billion, £87 billion and £70 billion respectively.

Those who follow these things will have added up the numbers and worked out that, compared with what the Treasury expected in the March budget, borrowing over five years will be £295 billion higher. Just the addition to borrowing averages roughly twice as much as the government should be borrowing to meet its now “temporarily” abandoned fiscal rules.

The public sector’s net debt, meanwhile, will go from 36.3% of gross domestic product at the end of March to 57.4% by 2013-14. That excludes the cost of the government’s banking rescues, whatever they turn out to be in the medium-term. There has been a lot of talk of historical parallels but in debt terms, this really is back to the 1970s.

Interestingly, very little of this extra borrowing and debt has much to do with Darling’s emergency fiscal package, even in the short-term. The package is worth £20 billion, with about four-fifths of that coming through in the 2009-10 fiscal year. Even then, however, that is only worth 1.1% of GDP.

To put that in perspective, government borrowing is predicted to increase from 2.6% of GDP last year to 8% in 2009-10 (via 5.3% this year). Without the package it would still have risen to 6.9% of GDP, slightly more than £100 billion.

What about the economics of this? Every radio and television discussion has been dominated by the question: Will a 2.5 percentage point cut in Vat make any difference to people’s spending decisions? To paraphrase Nick Clegg, the Liberal Democrat leader: Will a modest price cut make you buy that flat screen TV?

With apologies to him, this is a dumb way of looking at it. The effect of the Vat cut, if there is one, is cumulative. Along with sharply falling inflation, it will mean, according to the Treasury, that real household disposable income growth stays positive next year, if only by 0.5% to 1%. That is still consistent, it believes, with a fall in consumer spending of 1% or more, and a rise in the saving ratio.

The Treasury’s forecast of a 0.75% to 1.25% drop in GDP next year is broadly in line with the latest independent consensus (which is for a 0.9% drop) and its prediction of a bounceback in 2010 is in line with the Bank of England.

Long after that, however, we will be stuck, barring miracles, with these huge borrowing numbers. Higher rate taxpayers will be paying £2 billion a year more in various forms from 2011-12. Higher National Insurance contributions will be brining in £5 billion a year and rising from employers and employees from that same year.

We expected a hangover. What was staggering about today was how big the fiscal hangover will be and how long it will last. 2015-16, when the current budget is now expected to be back in balance, is a very long way away.