Sunday, February 08, 2015
Osborne needs to be careful with that axe
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

axeman.jpg

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

George Osborne has, in spite of everything, a pretty good story to tell on the budget deficit. The scale of the borrowing problem the coalition inherited in 2010 was huge, and was subsequently discovered to be even bigger.

Yet the deficit has come down significantly. Depending on which measure you choose, and where the final destination for borrowing is, between 55% and two-thirds of the necessary action has been taken. Getting there requires a bit more than one more heave but looks far from impossible.

The question is why the chancellor is choosing to present the task ahead in quite the way he does. Stay with me is his message, and there will be years more of spending cuts. Not only will taxes not be used to help achieve the remaining reduction in the deficit but they will be cut. Merely eliminating the deficit, meanwhile, will not be enough. The aim will be to achieve a permanent surplus. I shall return to this curious pre-election message in a moment.

First, the record, and I draw on the Institute for Fiscal Studies’ always excellent annual green budget, which has been published for more than three decades, and is often more interesting than the budget itself. There is also an interesting new report on debt from the consultancy McKinsey.

What has been the story of fiscal policy on Osborne’s watch? Many people think that in 2010 he pledged to eliminate the budget deficit by the May 2015 election. That is not the case. The aim was to get the so-called cyclically-adjusted current budget deficit down to zero (and beyond), but public sector net borrowing – the overall deficit – was predicted to be 2.1% of gross domestic product this year, 2014-15.

There has been slippage, quite a lot of it, so the overall deficit is officially predicted to be 5% of GDP this year. But that slippage is rather less than often portrayed.

Borrowing over this parliament has been higher than Osborne hoped but, as the IFS points out, the true figure for the cumulative overshoot compared with the coalition’s 2010 plans is £100bn, rather than the £200bn Labour is using in its election literature.

Had the plans sketched out by Labour before it left office been followed, the IFS says there would have been “significantly more borrowing”, which would have deferred but not avoided “the need for greater fiscal consolidation”.

The other misunderstanding about fiscal policy is that the chancellor, worried about a stagnating economy, somehow abandoned deficit reduction in 2012, thereby paving the way for recovery.

Again, that is not the case. What actually happened, as the IFS points out, was that official estimates of the size of the “structural” budget deficit – that which is not dependent on the economic cycle – increased between 2010 and the end of 2012. Osborne could have tried to compensate for that underlying deterioration but chose instead to defer the additional deficit reduction needed until the next parliament.

There are therefore three components to Britain’s deficit problem. There was the structural deficit Labour was running before the crisis, estimated to be between 3.9% and 5.3% of GDP. There was the increase in that deficit as a result of the crisis, and there was the further deterioration when it became clear that the supply-side of the economy – and productivity growth – had been damaged.

How much of the deficit has been eliminated? The IFS, noting Osborne’s aim of achieving a budget surplus of 1% of GDP by 2020, calculated that 55% of the tax has been completed, with 45% still to go. It is worth noting, however, that on the original aim of merely eliminating the current budget deficit (in other words continuing to borrow to invest), the chancellor is rather closer to finishing the job.

The IFS also used figures from the International Monetary Fund to compare Britain with other countries. They show that the scale of underlying deficit reduction in some countries has been staggering. In Greece it has been 20.3% of GDP, Iceland 17%, Ireland 9.9%, Latvia 8.2%, Portugal 8.1% and Spain 6.7%.

Underlying deficit reduction in Britain has been 6.6% of GDP, with 3.5% still to go. That ranks only seventh among advanced economies to date, a far cry from the idea that some kind of mad Frankenstein austerity experiment has been carried out. Another myth, that America under Barack Obama has eschewed austerity, is confounded by the figures. America’s deficit reduction has been 5.8% of GDP, not a million miles from Britain’s.

Indeed, figures I highlighted last week showing Britain is further above its pre-crisis level of GDP than all but two other G7 countries – Canada and America – give the lie to the argument that austerity has been to blame for weak growth. Germany, France, Japan and Italy have all had much less action to reduce their budget deficits, typically less than half that in Britain, and much weaker growth.

The other encouraging part of the story is provided by McKinsey, in their report Debt and (not much) deleveraging. Government debt has risen in Britain, as everybody knows. But Britain is rare in that corporate and household debt have fallen in relation to GDP. The result is that the increase in overall debt – leveraging – has been much smaller in Britain than in most other advanced economies.

So Britain is in 13th place overall in what McKinsey describes as real-economy debt, well below Japan, and below France, Italy, the Netherlands, Sweden, Denmark and others. That is a big change.

So there is much to commend about what has been achieved. Why then, to return to the question I posed at the start, is Osborne risking that he will not be around to finish the job by parading the hair shirt?

If more than 1% of voters know the difference between eliminating the cyclically adjusted current budget deficit and achieving an overall budget surplus, I would be surprised. Even if they do, many would share the scepticism of a good proportion of economists that it will ever be achieved.

If there is private polling showing that people want further deep cuts in public services, it runs counter to all the public polling I have seen. Instead, the chancellor’s commitment to achieving his budget surplus through such cuts has opened him up to the dishonest but potentially potent charge that he is taking the state back to the pre-NHS 1930s.

The tax cuts that the Tories are promising, notably raising the personal allowance to £12,500, are mainly more of the same. Many people would like to see the higher rate threshold raised but are likely to take the promise that it will happen with a pinch of salt. Increasing the inheritance tax threshold was a vote-winning move in 2007 but times have changed.

So I am genuinely puzzled. Osborne has a pretty good story to tell on deficit reduction and Labour has very little credibility on the issue. It would have been enough to say that he was sticking to his original plan (eliminating that cyclically-adjusted current budget deficit)- which is now Labour and Liberal Democrat policy - but that it is taking a couple more years to achieve it, allow us to finish the job, etc. Then, if the wind is fair, you can press on with trying to achieve that overall surplus.

Instead, he in danger of being portrayed as a mad axeman shrinking the state for ideological reasons, and he has allowed Ed Balls, his Labour shadow, as well as his coalition Liberal Democrat partners, to claim that they occupy the centre ground on deficit reduction.

There may be method in what looks like a bit of madness. As I say, I can’t quite see it.