A foretaste of a future where fiscal surpluses are the norm
Hamish McRae On the possibility of Balanced budgets
Tuesday 11 November 1997
This is the possibility - however shocking, ridiculous, even bizarre this might seem under a Labour government - that our public finances will move into surplus.
The point is simple enough. UK public finances were already improving rapidly under the previous government. In July Gordon Brown tightened fiscal policy further. Now, come November, the deficit looks like being narrower still. Of course governments can always think of ways of spending money and this one might break its spending targets, but on present trends it is plausible that there could be a surplus next fiscal year.
This possibility has up to now hardly surfaced in the markets, so I am grateful to the economic team at NatWest Markets for pointing out the way in which the twin deficits - the public sector deficit and the current account one - have been turning out much better than forecast.
The PSBR outturn last year, the one which ended in April, was pounds 22bn or 3 per cent of GDP. This year the Tories planned a further cut to pounds 19bn, which was then cut again by Gordon Brown to a planned pounds 11bn. Now the City forecasters are suggesting that the deficit will be narrower still, maybe pounds 8bn, which would be only 1 per cent of GDP. What seems to happening is that the faster-than-expected growth has been cutting spending, so though revenues are not doing particularly well the general borrowing picture is better than it seemed even a couple of months ago.
A deficit of 1 per cent of GDP would have seemed astounding three or four years ago, when things were repeatedly turning out worse than forecast, rather than better. But this might just be a foretaste. If you can get from 3 per cent of GDP to 1 per cent in this financial year imagine where you might get to next.
For the moment, forecasters are still thinking in terms of a small deficit - NatWest Markets forecast pounds 3.9bn, James Capel pounds 2bn - but when you are dealing with the difference between the two very large figures of government spending and government revenue, a couple of billion either way is well within the forecast error. So, unless there is some big change in government policy, a surplus for 1998 looks perfectly possible.
More about what this means in a moment. What about the other deficit, the current account one? City forecasters are still predicting a tiny deficit this year, after an all-square result last, but since the last three quarters for which we have figures are all in surplus, even that looks pessimistic. Whether this surplus might continue into 1998, though, is another matter.
Have a look at the graph, pulled together by NatWest, and focus on the way in which the two deficits seemed mirror-images of each other in the 1980s. In the middle 1980s the current account was in surplus and the PSBR in deficit. Then the late 1980s boom saw the two to switch: strong growth sucked in imports and pushed the current account into deficit, but the additional tax revenues and the cuts in benefit payments from this growth pushed the government into surplus. In the early 1990s recession reversed all this.
Now, however, the two lines seem to be moving together. The current account is already in surplus and as noted above the PSBR is fast heading that way. Question one: Will the two lines carry on together, or will they repeat the experience of the 1980s and diverge? Question two: Is there a broader message in the move of the twin deficits in the "right" direction?
The City consensus is that the narrowing of the PSBR will continue, though few are yet suggesting it will disappear; but everyone seems to doubt that the current account can continue to improve, for all see some sort of re-run, albeit in muted form, of the 1988 boom, complete with its surge in imports, etc. NatWest Markets' forecast of a 1998 current account deficit just under pounds 4bn is the lowest in the City. I suspect they are right, for the underlying structural forces which have improved the UK's current account should carry on working. So while some deterioration is on the cards, it need not be on anything like the scale of the 1980s.
If that is right, the second question - the hunt for a broader message - is very interesting indeed.
To answer it, imagine how people would react were the government to find itself back in surplus. Imagine how Mr Brown would react. Spend the surplus? Doesn't sound right. Remember the golden rules of spending - that governments should only borrow for investment, not for current outlays? No, there might be some modest additional spending but I cannot see it suddenly becoming fashionable to blow the surplus, particularly since in a year or two we will be beginning to contemplate the downswing of the economic cycle. That was, after all, the mistake Lord Lawson made.
No, I think that being the only G7 government with a fiscal surplus will be taken as something commanding respect among the Chancellor's peers, and that it will be surprisingly popular among voters. The actual surplus will be transient, the cycle will see to that, but the idea that normality is not running a deficit will gradually take hold not just in the UK but across the developed world.
The idea that budgets should be balanced was the norm before the first oil shock in 1973/4. We are, in so many ways, going back to a world more like the 1950s and 1960s, with low inflation and compared with the 1980s, quite low unemployment. Going back to the norm of a balanced budget fits naturally into that environment. Of course, given adverse demography, governments should really be running surpluses ... but that is a story for another day. Let's get rid of the deficits first.
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