Thursday, April 23, 2009


Yet is the government at last being realistic about the scale of this disaster? Can Labour hope to get away with it, economically or politically? Does it deserve to do so? These are the questions for markets and analysts now, and for voters at some point in the next 12 months. My answers are, briefly: No, No and No.

In terms of the overall picture, the salient figures were already well known: instead of an economic contraction of 1 per cent this year forecast in the pre-Budget report, the Treasury now forecasts a decline of 3.5 per cent; instead of public sector net borrowing of 8 per cent of gross domestic product this financial year and 6.8 per cent next year, falling to 2.9 per cent in 2013-14, we now have 12.4 per cent this year, followed by 11.9 per cent next year and 5.5 per cent in 2013-14; and instead of net debt at 57 per cent of GDP in 2013-14, we now have net debt at 79 per cent.

This is a horror story. But it could, of course, be worse: the economy may not recover as hoped; losses on support for the banks could, as the International Monetary Fund suggests, be far bigger than the 3.5 per cent of GDP now expected; and, above all, the creditworthiness of the British government could come into question, with devastating consequences. The government is flying on a wing and a prayer. Can it – or its successor – land the aircraft? As a British citizen, I do hope so. But nobody can now be sure of this. Can a government that made large claims for the quality of its stewardship survive such a debacle?
Perhaps the most striking single figure in the Budget is that the Treasury now believes cyclically adjusted net borrowing will be 9.8 per cent of gross domestic product this financial year. In other words, virtually all of the overall net borrowing requirement of 12.4 per cent of GDP is structural.

The Treasury’s implicit view is that this is a sudden and unexpected event, consequent on the collapse of corporate profitability, particularly in the financial sector, and of the housing market: it shows the structural net borrowing requirement at only 2.7 per cent in 2007-08 and 5.7 per cent in 2008-09. But this view is highly implausible. More realistic is that, as happened in the boom of the late 1980s, but on a bigger scale, the Treasury confused a super-boom with a sustainable economic position. Now, after the collapse, the Treasury admits that the structural fiscal position is far worse than it thought. If it – and, we must admit, many others – had realised how fragile the economic and fiscal position was, they would have recognised that deficits and net public debt were far too high.
Behind this forecast is a promise and a hope: the promise is that real public spending will remain roughly constant between 2010-11 and 2013-14 and then rise at only about 0.5 per cent a year over the rest of that parliament and, implicitly, well into the next; the hope is that the economy will recover vigorously, with GDP already growing at 3.5 per cent in 2011, after 1.25 per cent next year. These are not impossible forecasts. But they imply a resolution that can hardly be expected of any UK elected government, a vigour that can no longer be assumed of the storm-tossed British economy and an amount of luck, on the world economy and losses in the raddled banking system, that cannot be taken for granted. The horrible truth is that the government’s forecasts are still very far from the worst imaginable.
I have no idea whether the government can both get away with this optimism and postpone the moment of truth at least until after the general election. Markets have been forgiving. The difficulty with assuming that this will continue is that this is how markets tend to behave – until they cease to do so. Should investors decide that a return to fiscal stability has become a remote prospect, they may turn against the UK suddenly and brutally. The populism of the Budget, with its fiscally futile attack on relatively high earners, makes this even more likely.

Finally, does the government deserve to get away with it? It is true that this is a global crisis in which many economies have been as hard hit as the UK. But, according to the Organisation for Economic Co-operation and Development, no other big member has suffered as large a deterioration in its structural fiscal position as the UK. In retrospect, the government was far too optimistic about the structural solidity of the UK economy and its finances. While many others were equally blind, it is hard for a government to escape responsibility for so huge a mistake.
I have sympathy for the decision not to tighten fiscal policy during the worst of a recession
. But I would also want to see determination to take the measures needed to return the fiscal position to health by the end of the next parliament. This will require action on both revenue and spending. Understandably, perhaps, the chancellor failed to spell out the scale of the challenges that lie ahead even if the economy were to recover robustly. Yet what is in prospect is year after miserable year of austerity.
The challenge for both government and the opposition is to show how they will bring the budget back under control. Neither side is being honest about what this means. If this failure leads to a collapse of confidence, that will prove the worst mistake of all.

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