Sunday, May 16, 2010
Digging our way out of the deficit the hard way
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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The past two or three years have taken me into the unknown. I had never seen a full-blown credit crunch, the near meltdown of the global banking system or bank nationalisation in Britain. Nor had I seen a national coalition government in Britain.

Winston Churchill's coalition government of 1940 had a pretty straightforward goal: to win the war. Ramsay Macdonald's peacetime national government of 1931 before my time came into being to deal with an economic crisis.

I do not know whether either published coalition agreements. Had the 1931 government done so, it would not have been worth much. The cabinet of Conservatives, Liberals and Labour disagreed fundamentally, notably on whether to respond to the depression by putting up tariffs. Collective cabinet responsibility was suspended.

So last week's coalition agreement hammered out by Conservative and Liberal Democrat negotiators was a big step forward. Instead of two rival manifestos there was a seven-page document, outlining the areas on which the coalition partners could agree. More on that in a moment.

Those of us who attended Mervyn King's press conference at the Bank last week saw a new man. After 13 years of independence under Labour, which gave the Bank its head, the governor could look forward to an enhanced role under the new government.

He was free to say nice things about Alistair Darling there had been rocky times but his steady presence had been invaluable and arguably even nicer things about Gordon Brown, and the long evenings they spent bailing out the banks. I cannot imagine much affection between them, or even a manly parting hug, but there appears to be a lot of respect.

Where there was love, from King at least, was for the Lib-Con outline proposals for cutting the budget deficit. The governor, who had seemed to side with Labour in one of the core arguments of the election debate, that it would be unwise to cut too soon, has changed his mind.

Stronger recovery evidence and the lessons of the eurozone crisis delay too long and you are toast meant he now fully supports the coalition plan. If Vince Cable, the new business secretary, can support spending cuts this year of 6 billion, having ridiculed them during the campaign, it was much less of a journey for King to do so. As for the "significantly accelerated reduction" in the budget deficit set out in the coalition agreement, you would expect the Bank governor to sign up to that.

So has the Treasury. Treasury officials have been as concerned as anybody about the sharp rise in the budget deficit and the rise in government debt. They understand the reasons but it does not make them any less determined to get to grips with it. Their private nightmare was a Labour-Lib Dem coalition with Gordon Brown at the helm, because they did not believe he could ever preside over genuine spending cuts.

So the new government is off to a good start. Item one of its the 11-point coalition agreement was headed deficit reduction and was crisp and to the point. By the time the negotiators got to items 10 and 11, civil liberties and environment, you get the sense they had rather lost the will to live.

Unfortunately, however, item one was followed by items two "spending review" and three, "tax measures". Here, it would have been useful to have had somebody else in the room, perhaps the Institute for Fiscal Studies or Sir Alan Budd, head of the new Office of Budget Responsibility.

In the horse-trading that led to the new government, the deficit task was made much harder than need be. As in the campaign, the parties traded goodies and giveaways, leaving the nasties until later.

For the past two weeks, and on occasions before, I have written about the likelihood of a Vat rise to 20%, to take effect next year. My understanding is that nothing like that was discussed during negotiations, which could be a source of pre-budget tension.

True, the Tories made some surprising concessions. I gather George Osborne was not too upset at having the inheritance tax millstone the pledge to increase the threshold to 1m removed from round his neck. But by accepting Lib Dem proposals to bring capital gains tax on non-business assets in line with income tax, the Tories have moved sharply from preparing to cut capital taxes to one of the most punitive regimes since Labour was squeezing the rich in the high-inflation 1970s.

It would be easy to forgive the coalition agreement sillinesses such as references to "Labour's financial crisis" (the banking crisis), were it not for other problems. The pledge to cut spending by 6 billion this year, for example, is accompanied by a promise to find resources to "support job creation and green investment".

The promise to increase funding in real terms for the National Health Service every year may be a reflection of reality and age-related pressures but it makes the cuts that will be needed elsewhere all that much harder. Funding a "significant premium" for disadvantaged pupils from outside the education budget probably means schools' spending overall will escape the axe too.

Maintaining the target of raising overseas aid to 0.7% of national income salves a few consciences but comes at a time, not just of austerity, but when recent expert accounts have concluded that much aid is a pretty good way of throwing money away without obvious benefit.

"We're all in this together", if it applies anywhere, applies across the public sector. Median regular pay in the public sector, 459 a week, is 9% higher than the private sector, 421. Some of that reflects the fact that the public sector has more graduate and professional jobs. That, however, is irrelevant now. Public sector pay has risen much faster than private sector pay over the past two years. A sacrifice has to come.

In Spain, public sector pay has been cut by 5%. At their first cabinet meeting, ministers accepted a 5% cut in their pay and a freeze for the rest of the parliament. A 5% cut in public sector pay would save about 9 billion and make a significant hole in the roughly 50 billion of deficit reduction measures yet unspecified. Ringfencing the NHS makes that harder. Would the NHS feel ringfenced if staff were forced to take a 5% cut? Protecting low-paid public sector workers from the pain, also in the agreement, makes it harder still.

There are similar problems on the tax side. This was the moment when the coalition partners, after a cursory look at the books, could have abandoned their pre-election tax promises. Instead, next April will see a shelving of the planned employers' National Insurance rise and, in lieu of a shelving of the rise for employees, a nod towards the Lib Dem policy of raising the personal income tax allowance to 10,000.

There is nothing wrong, I stress, with either, as there would be nothing wrong with abolishing income tax. But we are in an era of tax rises, not cuts. Cutting the deficit will involve harder decisions than putting together a coalition agreement.

PS: High on my list for statistical confusion are the unemployment numbers. Last week's apparently grim news from the Labour Force Survey (LFS) showed that unemployment had soared to 2.51m, as employment slumped 76,000 to 28.83m. Call that a recovery? The new prime minister said it was part of the grim inheritance.

In fact, a closer look reveals that employment is 5,000 higher than the ONS was reporting a month ago and unemployment, if it was rising at all in early spring, was doing so only marginally. The other measure, the monthly claimant count, was down by 27,100 to 1.52m in April, and has now fallen for five of the past six months.

Remember unemployment might have been a lot higher now, with plenty of pundits predicting 3m or 3.5m on the LFS measure. As the Bank noted, the recession's 2.3% drop in employment is much smaller than the fall in gross domestic product.

What's interesting is the contrast between the young and old. In past recessions over-50s have borne the brunt of job cuts. This time, there are more men aged 50-64 and women aged 50-59 in jobs than at the recession's start and a 10% rise in employees beyond retirement age. In contrast, employment among 16- to 17-year-olds is down 31%, while for 18- to 24-year-olds the drop is more than 8%. More have been staying in education.

David Willetts, new minister for universities and science, set out in a book The Pinch how baby-boomers stole their children's future. They're still at it.

From The Sunday Times, May 16 2010