By Martin Wolf
Last updated: June 22 2010 21:04
Fortune favours the brave, or so George Osborne, the new chancellor of the exchequer, and the coalition government must hope. For brave he has surely been. He has announced a dramatic fiscal tightening, though the gory details are to be revealed in the spending review to be completed by October. Yet what he has already outlined is a savage Budget. The government must now win the argument that this tightening was essential. If public sector unrest and a weakening economy bite hard over the next few years, the bravery is going to look like rashness.
Yet there is much in the new dispensation to like, not least the return to the plain old red book unadorned by the phraseology of the public relations industry. Democracy is change without revolution. So it was also good to see the burial of Gordon Brown’s discredited “golden rule”, which, noted Mr Osborne, the government is set to miss in this cycle by £485bn! As he rightly noted, “past prudence was an excuse for future irresponsibility”.
The new Office for Budget Responsibility looks a genuine improvement, though it may manage to discredit itself, too: forecasting is an uncertain business. Yet this change is surely easier to defend than the massive upheaval about to fall on financial regulation, through the abolition of Mr Brown’s Financial Services Authority.
The core of this Budget lies in the plan for extra fiscal tightening. Here are some relevant figures for what lies ahead: a decline in public sector net borrowing of 9.9 per cent of gross domestic product, from 11 per cent in 2009-10 to 1.1 per cent in 2015-16; a fall in the current fiscal deficit of 7.5 per cent of GDP to zero in 2015-16; a decline in cyclically adjusted net borrowing of 8.4 per cent of GDP to 0.3 per cent in 2015-16; and a shift in the cyclically adjusted current balance of 6.1 per cent of GDP to a surplus of 0.8 per cent in 2015-16.
What does this mean? It means, quite simply, tightening until the pips squeak. Structural reductions in public net borrowing will average 1.4 per cent a year – unquestionably, an impressive headwind against growth.
This is also a sizeable tightening against the plans of the previous government. On the basis of the forecasts of the Office for Budget Responsibility, cyclically adjusted net borrowing and the cyclically adjusted current budget will be close to 2 per cent of GDP smaller in 2014-15 than previously forecast. As a result, net debt is expected to peak at 70 per cent of GDP in 2013-14 (see charts).
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So how will this tightening be achieved? Quite simply, the Budget announces an additional £40bn in spending and tax decisions, £8bn in tax and £32bn in spending by 2014-15, of which £11bn are specific measures on welfare. In all, discretionary fiscal tightening will amount to the massive total of £113bn by 2014-15, 74 per cent of this in lower spending and the rest in higher tax.
Some quite controversial measures were given on Tuesday, notably the rise in value added tax to 20 per cent, and the cuts in a range of benefits. But the burden of the cuts remains to be revealed in the forthcoming spending round. As the chancellor put it, laconically, once the commitments to financing real increases in spending on the National Health Service and protecting aid obligations are allowed for, “the Budget figures imply that other departments will face an average real cut of around 25 per cent over four years”.
The chancellor made much of the government’s commitment to transparency. But nothing in the election campaign prepared the British public for this bloodbath. The scale of the adjustment is also indicated by the fact that total managed expenditure is forecast to collapse from 47.5 per cent of GDP in 2009-10 to 39.8 per cent in 2015-16, while receipts are merely to rise from 36.6 per cent of GDP to 38.7 per cent. The two-year freeze in public sector pay will not take the government far on this road. Mass public sector job losses lie ahead. Given the squeeze being imposed, nominal pay cuts will be required if services are to be maintained in any reasonable shape.
The chancellor stated, boldly, that: “We are a progressive alliance governing in the national interest.” One has to admire his nerve, since the evidence provided in the Budget provides only partial support for this view: the adverse impact on the poorest 10 per cent is harsher than on most richer groups even in 2012-13. This may worsen thereafter. But some of the measures, though modest in their impact, are imaginative: the temporary raising of thresholds for national insurance contributions, for example. The adjustment in the capital gains tax for higher-rate taxpayers, to 28 per cent, is politically shrewd, though the absence of indexation remains a scandal: this is taxation of inflation. I quite like the idea of the levy on banks, as a crude way of internalising the costs of excessively large balance sheets. Competition among governments to lower corporation tax rates is harder to defend. The UK’s reductions will, no doubt, trigger further cuts elsewhere to which the UK will then respond.
Yet the core of this Budget is two gigantic gambles. The first is that the government can manage the public relations of its grinding war on spending. This is going to be brutal. To defeat the opposition, it will have to carry an unprepared public opinion. In particular, the government must persuade the public that the overall balance of these changes is fair, in the teeth of a rejuvenated Labour party.
The second gamble is over the impact of the fiscal tightening on GDP. The Office for Budget Responsibility forecasts growth of 1.2 per cent this year, 2.3 per cent in 2011 and 2.8 per cent in 2012. This includes powerful contributions from business investment and net exports. In 2012, for example, business investment and net exports are forecast to generate 1 and 0.9 percentage points of growth, respectively. Thus, the government must not only hope that domestic private spending is little affected by the squeeze, but that spending on UK exports is little affected by the fiscal squeezes it has encouraged other governments to undertake. The Bank of England must also play a crucial role, with low interest rates and even more quantitative easing in the years ahead.
Massive fiscal tightening was ultimately inevitable. But perhaps only such a young government – in age and in time in office – would gamble so much on such a fast adjustment, so early in its life. As a citizen of the UK, I hope it pulls it off. Maybe, its sense that the UK could not get away with a measured approach is right: we will never know. But this gamble has now defined the government. If it is seen to have failed, it will be finished.
Copyright The Financial Times Limited 2010.
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