Sunday, November 29, 2009
Don't expect too much blood from Darling's axe
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Normally at this time of year I would be reflecting on the chancellor’s pre-budget report rather than looking forward to it. But the PBR is late - not until December 9 - so there are two Sundays to go.

As always with these things, that means a lot of decisions have yet to be taken. But the broad thrust of what Alistair Darling intends to say is taking shape.

There has been a subtle shift in the tone of the debate. Last week’s beauty contest at the CBI’s annual conference for the three main party leaders included tough talk on getting the budget deficit down, which the CBI liked, with David Cameron promising “a decisive plan that starts now”.

But there was also a lot of commitment to getting growth going. After the austerity message of the Tory conference, Cameron pledged an “emergency growth budget”, within 50 days of taking office. The only tax changes highlighted were cuts, reducing the main rate of corporation tax from 28% to 25% and the small companies’ rate to 20%, paid for by reducing reliefs.

Government advisers believe this shift reflects a concern among senior Tories that too much talk of austerity and getting down the deficit in a rush was starting to frighten both voters and some businesses.

That is why Darling’s message will focus on jobs and growth. Anybody expecting him to stand up on December 9, clad from head to toe in hairshirt, and issuing bloodcurdling warnings of how much pain is on the way, will be disappointed.

Though he would have liked to be armed with official figures showing a return to growth, rather than the revised 0.3% third quarter fall reported by the Office for National Statistics last week, he will stress the need to keep supporting the economy.

He will stress the fragility of next year’s predicted recovery. Dubai World’s request to creditors last week for a six-month debt standstill, which hit markets hard, was a reminder that while the worst of the crisis is over, the scope for aftershocks remains.

Independent forecasters have moved into line with the Treasury’s budget forecast of 1% to 1.5% growth next year but Darling is unlikely to revise his prediction much, despite the Bank of England’s expectation of 2% growth in 2010.

He will emphasise the jobs saved by government action in the recession, and the need to keep on saving them. In September Darling delivered the Callaghan lecture in Cardiff, in memory of the former prime minister, and talked at length of the “active state” and the enabling role of government.

He thinks this is the crucial political divide, exposed during the crisis. Without government, the recession would have been worse and the banking system would have collapsed, as last week’s Bank revelation of £61.6 billion of Treasury-indemnified lending to RBS and HBOS demonstrated. There was a bit too much fuss over that revelation but it makes the point.

Labour’s best electoral hope depends on a bit of a caricature; persuading voters that it was the government that acted to protect its citizens from the worst of the crisis, while the Conservatives would have walked by on the other side of the road and are slavering to slash spending.

How does this fit in with the spending cuts needed for the credible deficit reduction programme Mervyn King, the rating agencies and the markets are anxious to hear a lot more about on December 9?

The answer, it seems, is that outsiders will have to wait a little longer for the detail. Because there has been no comprehensive spending review (CSR), there can be no detailed breakdown of public spending beyond 2011. We know infrastructure spending will halve over the three years from 2011, though officials point out that even the level to which it will fall - £22 billion - is in line with its long run average.

On tax, there may be some unpleasant surprises, but plenty of tax hikes are in the pipeline, including the new 50% top tax rate from April and higher National Insurance contributions in 2011. Darling will not be aiming for headlines that scream of additional tax pain on the way.

Will this satisfy the markets? This is where the government’s Fiscal Responsibility Bill, announced in the Queen’s speech, comes in. Part of its purpose is getting through Labour’s “make me pure but not just yet” period leading up to the election.

The numbers from the PBR, implying a halving of the budget deficit by 2013-14 and a move towards a balanced budget that, will be embodied in the legislation. That way, ministers hope, they can negotiate the tricky few months leading up to the election, which will probably be on May 6.

Darling will also argue that the economics and politics run together on this and that taking an axe to the deficit too soon would snuff out the recovery.

A vigorous debate has broken out among the think tanks. Is it better to wield the axe on the deficit quickly, giving the economy room to breathe? This is still essentially the Conservative approach, despite last week’s shift of tone. Or is better to wait until the the recovery is well established?

Policy Exchange, a Tory-leaning think tank, has looked at 12 episodes of serious fiscal consolidation, six in Britain and six international. It concludes that, as long as the focus is on spending cuts rather than tax hikes, “fiscal consolidations can promote growth and recovery – particularly by enabling a looser monetary policy than would otherwise have been the case.”

The government, in other words, should get on with it. I have drawn comfort from one of these episodes, the 1990s, when Britain’s budget deficit moved from of 7.7% of GDP in 1993-4 to a surplus in five years.

Public spending dropped from the equivalent of 43.7% of GDP to 36.3%, while tax revenues rose from 31.8% to 36.3% of GDP. Much of this reflected the impact of recovery on spending and revenues, though there was also plenty of deliberate action. And, crucially, it did not prevent the economy growing well throughout the 1990s.

Another think tanker, Giles Wilkes of CentreForum, argues for caution. Interest rates and the pound are already very low and the extent of government involvement, most notably in the banking system, goes deeper than in the past. The history of the 1990s, he suggests, is unlikely to repeat itself, and relies on too rapid a bounceback in exports and investment.

There is something in both arguments. We should also remember that the weight of the fiscal consolidation by the Tories in the 1990s was not felt until 1994 and 1995, a couple of years after the economy began to recover. The markets and business want tough talk from the politicians on deficit reduction and that talk has to be convincing. It would be a mistake, however, for it to be converted into action too soon.

PS Sometimes I feel obliged to defend the family name. On the Today programme, my former colleague John Cassidy, interviewed about his book How Markets Fail (Penguin, £25), blamed the free-market economics of Adam Smith, adopted uncritically by Alan Greenspan.

You might have thought, listening, that Smith’s ideas had been discredited by the credit crunch. That, however, is far from the case. Were Smith alive today, he would have been as critical as the bankers, and the failure to regulate them properly, as anybody.

In fact, as Cassidy makes clear in the book, Smith was even more sceptical of the motives of bankers as of most businessmen. He thought banks should not issue notes to speculative lenders and regulating them was as necessary as building party walls to prevent fires spreading. So don’t blame Smith. Blame those who misinterpreted him.

From the Sunday Times, November 29 2009