Sunday, August 25, 2013
Growth's back - but the deficit's still huge
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

Public sector net borrowing:

borrowing.png

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

When will we know the recovery is genuinely making a difference? A sustained increase in gross domestic product (GDP), taking it above and beyond pre-crisis levels, is one obvious test. A reduction in unemployment, which has remained stuck at about 2.5m in spite of record numbers in work, is another.

Both are very important. For George Osborne and the Treasury, however, one vital measure is the budget deficit.

Growth this year has come through in time to get many of the chancellorís critics off his back. At the point when the International Monetary Fund appeared ready to join those calling for a major rethink of his fiscal strategy, the economy perked up.

Friday's figures showing an upward revision to growth to 0.7% in the second quarter, with that growth remarkably well balanced between sectors and the different components of expenditure, were very good news.

Osborne will not be off the hook, however, without firm evidence that the deficit is decisively on the way down. So far that evidence is more elusive than it should be.

Recent days brought news of a rare July budget deficit, with public borrowing, adjusted for the various special factors, of £0.5bn, compared with a surplus (a debt repayment) of £0.8bn a year earlier.

We should not make too much of that. Borrowing is the difference between two big numbers. July 2012 was initially reported as a deficit but later revised.

But the trend for the first four months of this fiscal year, April-July, did not suggest a deficit on its way down. Public borrowing so far in 2013-14 is £36.8bn, compared with £35.2bn for the corresponding period of 2012-13.
Growth has returned but it is not, it seems, reflected in the public finances.

In some ways this is a mirror image of the past three years. As the Office for Budget Responsibility (OBR) has noted, public borrowing - like employment - has been better than expected given GDP.

One explanation for that is that the GDP figures will be revised. Another is that the deficit is not as automatically linked to growth as we have come to expect.

In June 2010, at the time of Osborneís June 2010 emergency budget, the OBR predicted £354bn of borrowing during the coalitionís first three years, partly on the back of a recovery strengthing from 1.2% growth in 2010 to 2.3% in 2011 and 2.8% in 2012.

In the event, the coalition borrowed a little more, £374bn, despite a big growth undershoot. The numbers we have at present for growth over that period are 1.7% for 2010, 1.1% 2011 and just 0.2% 2012.

True, the profile is different from that envisaged by the OBR. 2012-13 borrowing was predicted to be £89bn, rather than the £116.5bn currently estimated. That is likely to be revised, but only an extreme optimist would expect it to get down to £89bn.

So where do we go from here? Is this the recovery that does not get rid of the budget deficit? After all, five years of good growth was enough, alongside austerity, to move Britain from a very large budget deficit, 8% of GDP, to a surplus in the 1990s.

Treasury officials, responding to the latest figures, pointed out that tax revenues are consistent with the growth story, up 3.6% in April-July on a year earlier, against a 3% OBR forecast for the full year.

Some of that, however, is due to top rate taxpayers shifting income into the current tax year, so that it would be taxed at 45% rather than 50%. The explosion of bonuses in April, with some follow-through in May, was no accident.

Overall bonuses in 2012-13 were up by just 1% on the previous year. In April, however, with the new 45% rate in place, bonuses showed a 62% rise on a year earlier, followed by a 22% increase in May.

The Treasury also pointed out that borrowing may have been boosted by the timing of public spending, particularly by grants to local authorities, where there was a greater concentration of spending at the start of the new fiscal year, as well as health, education and overseas aid.

Whitehallís current expenditure in April-July was £217bn, up 4.3% on a year earlier. That is a strange kind of austerity. For once this was not driven by benefits, up a modest 1.5%, but other spending.

Some of this spending is front-loaded, particularly grants to local authorities. It needs to be. The OBR forecast for full-year current spending, 2.2%, is barely half the rate at which it has risen so far this year.

So what will happen? There is a good chance that borrowing numbers will improve as the year goes on, as last year. Only a few months ago many predicted a borrowing outturn of £135bn or more for 2012-13, well above the £116.5bn outturn.

In theory, the deficit will rise this year if the OBRís latest forecast is accurate. Its prediction, made in March, was for borrowing of £120bn. I think there is a good chance it will come in quite a bit below that, no more than £110bn, as stronger growth (the OBR expected only 0.6% this year) feeds through to revenues. Some City economists, including Philip Shaw at Investec, agree.

Osborne will be relieved that borrowing remains on a downward track, as it has each year so far he has been at the Traesury. What we are not seeing yet is a decisive reduction in the deficit of the kind we saw in the 1990s. Anything above £100bn for annual public borrowing is still enormous, around 6% of GDP, adding to the £1,193bn stock of public net debt.

There are reasons for that, beyond the fact that growth has yet to gain cruising altitude. Weak pay weighs down on income tax revenues and, via in-work benefits that top up peopleís incomes, adds to public spending.

Corporate tax receipts are likely to remain subdued, because multinationals have become more adept at avoiding tax and because the cash cow of the financial sector has turned into a tiny calf.

We should not be too pessimistic, Some of these factors will fade over time. But the numbers confirm what we probably already knew. It is a lot easier acquiring a budget deficit than getting rid of one.