Sunday, March 28, 2010
Fiscal fog slowly lifts but axe has yet to fall
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


I have a memory of budgets being rather cheerful, uplifting affairs. MPs would queue for hours to bag their seat in the Commons chamber and dress up specially for the occasion.

Chancellors would be pictured in their local pub the Sunday before with a pint of the beer they were about to slap extra duty on. On budget morning there would be a walk among the St James's Park daffodils for photographers, with wife, dog, or both.

Now it is much more mean-spirited. My test for Alistair Darling's budget, as described here last week, was that he did no harm, which is the most you can expect in a pre-election budget from a chancellor under intense political pressure. He passed that test and even did a few things that, at the margin, will help Britain's beleaguered small and medium-sized firms.

Of course it would have been better if he had provided a full and frank disclosure of the spending cuts that will be needed to reduce the still-gaping hole in the public finances. A comprehensive spending review is not needed until this summer but could and should have happened last year, in line with the two-year pattern established in 1998.

That review, according to the Institute for Fiscal Studies' post-budget analysis would require departmental spending to drop 3.1% a year in real terms from 2011, a cumulative fall over four years of 12%. Outside protected areas such as health, schools and overseas aid the cumulative fall over four years is closer to 25%.

Darling did not come clean on this, perhaps understandably. The problem is the nature of our political system, particularly in a pre-election period. Opposition politicians call for honesty and transparency but offer none in return.

So George Osborne, shadow chancellor, based his attack on the budget on an apparent stealth tax hitting 30m people the freezing of income-tax allowances. This, I am afraid, was nonsense from a man who hopes to be chancellor in a few weeks.

The April allowance uprating is based on the previous September's retail price inflation rate. Then, inflation was negative, and in theory Darling could have cut allowances. Freezing them was in no way a stealth tax. Tory supporters, and many in business, would rather the shadow chancellor directed his fire at the new 50% tax rate, coming in on April 6.

Even Vince Cable, the nation's favourite financial uncle, is not above these games. The Liberal Democrat Treasury spokesman, when criticising Darling for failing to provide details of spending cuts, named cancelling Eurofighter and Trident's replacement as two things he would do.

However, cancelling Eurofighter would cost, as well as lots of British jobs, huge sums in compensation that mean it is cheaper to buy the planes. Not replacing Trident has minimal relevance for the public finances for the next decade.

Cable recently attacked the rating agency "clowns" holding Britain to ransom. Standard & Poor's and Fitch issued post-budget statements suspending judgment on the AAA status until after the election.

They must do what they think fit, though it seems to me they are using the status of Britain's sovereign debt for a bit of cheap marketing. In May last year one agency, Standard & Poor's, revised the UK's outlook to "negative" on the basis of a prediction that public-sector debt would hit 100% of gross domestic product by 2013. Since then, the Treasury has twice revised down its projections for the debt ratio, to 74.5% of GDP in 2013-14 now. The S&P forecast would require some 450 billion of more borrowing over the next four years than the Treasury projects. Anything is possible but that would require more terrible recessionary years for the economy.

Everybody is getting in on the act. You might think Bill Gross, head of Pimco, the world's biggest bond fund manager, would have a more considered view than the daft statement that Britain is sitting on a "bed of nitroglycerine". But that's what he said, and his firm is happy to repeat it.

If there is one thing we learnt last week, it is that fiscal forecasting is prone to huge errors. It is only three months since the pre-budget report but the Treasury was able to shave 11 billion off its borrowing forecasts for the current year 2009-10, cutting it from 178 billion to 167 billion.

That is not the half of it. Some of the chancellor's harshest critics were those who were predicting much bigger deficits. Back in October, several City forecasters had borrowing forecasts this year of more than 200 billion, and some of 220 billion. There was a similar pattern for 2010-11.

Let us assume the Treasury's forecasts of 167 billion followed by 163 billion are right. These are still enormous numbers but imply that borrowing over two years will be 100 billion less than the gloomiest forecasters expected.

If that kind of change can happen over five months, how can anybody say with any certainty that the government's fiscal forecasts are good, bad or indifferent five years ahead? A little humility is in order.

As for whether borrowing can fall in line with Treasury hopes, only two things matter. The first is whether growth comes near the Treasury projections that some analysts have attacked as wildly optimistic.

Some people appear to think Treasury economists assume we will go back to a pre-crisis norm as if nothing has happened. That is not so. The Treasury is simply assuming this battered and bruised economy will follow the same pattern as it did when it was battered and bruised by the recessions of the early 1980s and 1990s, when growth comfortably exceeded 3% for some years.

Economies grow faster in recovery phases than after a long run of growth, even if it takes a while to get started. That is the basis of the Treasury's forecast and the Bank of England's. The Bank has a weapon, keeping interest rates low, to ensure it happens. This time may be different but another crisis lesson, surely, is the danger of assuming this time is different.

The other thing that has to happen is that the government, or its successor, delivers on its deficit-cutting pledges. The good news, according to the Institute for Fiscal Studies (IFS), is that the hole that will not be closed by growth has come down from 90 billion to 66 billion between last year's budget and last week's.

The bad news is that it has proved far easier to identify and announce the tax rises that will close that gap, 19 billion, than spending cuts. The axe will fall hard on public-sector capital spending infrastructure and some genuine other cuts were announced, or at least re-announced, last week. The IFS believes savings from a 1% cap on public-sector pay, spending reductions in low-priority areas and pensions add up to a credible 9.4 billion. Neither it nor anybody else believes much of what the Treasury said about efficiency savings.

The fiscal fog is slowly lifting, despite the uncertainty. If things continue to head in the direction of recent months, a resolution is in sight to the nightmare of Britain's public finances. What we do not know, yet, is who will actually be wielding the axe.

PS: Thanks for the numerous entries to the competition to win The Age of Instability, my new book. If I sell as many copies as the number of people who have entered the competition, it will be a bestseller. This is not to deter anybody from trying; entries close this Thursday.

Anybody who missed the questions last week can find them online. Judging by the answers so far, and the list of culprits for the credit crunch, readers are pretty well informed about what got us into this situation.

From The Sunday Times, March 28 2010