Hamish McRae: Brown can bend the rules all he likes, but he's not the one who'll be left to balance the budget
Sunday, 20 July 2008
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So the Government is going to change its fiscal rules. In economic terms, this makes sense, given where we are now. But the much more important news at the end of last week was what was actually happening to the fiscal situation. So we will start with that and then come to the rules business in a moment.
During the first three months of this financial year, the Government has borrowed £24.4bn – up from £14.7bn in the first quarter of last year, itself a record. So three months into the financial year, we have borrowed more than half the amount we are supposed to borrow for the entire year, as you can see from the first graph. The current budget – the one that is supposed to be balanced over the economic cycle so the Government borrows only for investment – was in deficit by £20.4bn, up from £12.5bn the previous year. I actually worry less about this budget than the total one, because the Government can fiddle what is investment and what is current spending, but taken together they are really awful. By the way, if you don't believe the Government fiddles the figures, listen out for ministers relating how they have "invested" £Xm in something or other. Nearly always they are referring to current spending, but to say "spent" does not sound as good. This sort of dishonesty, encouraged by the marketing minders who advise ministers, undermines confidence in real public investment.
So where will the total deficit be this year? When, some months ago, I warned that we might get to £50bn, I thought I was pushing it. Now I think we will be lucky to get in below that. It will probably be the highest in the G7 countries, way above the Maastricht rule for 3 per cent of GDP and at a level that under-mines confidence in the financial markets.
The size of the budget deficit is very sensitive to economic growth. If growth is higher, tax receipts tend to rise, and vice- versa. Conversely, if lower growth starts to push up unemployment and demand for other benefits, government spending starts to rise. Last year, with growth at 3 per cent, the deficit was a bit under 3 per cent of GDP. This year, the Treasury forecast is for growth in the range of 1.75 to 2.25 per cent, but at best it will be at the bottom of that and more probably below it. The new IMF forecast last week put growth at 1.8 per cent this year, and I don't think we should rule out the Government squeaking in on the forecast. But in a way that is more alarming: if growth is more or less OK, then the revenue shortfall is even more worrisome. The private forecasters are gen-erally more gloomy. For example, the new forecast from the Ernst & Young Item Club, out tomorrow, has growth this year at 1.5 per cent.
But if we are in trouble this year, what about next? Here the forecasters are all over the place, with some, such as the IMF, expecting a slight increase in growth and others anticipating it will be worse. My own instinct has long been that next year will be more of a problem than this one, but the truth is, we don't know. Predicting the impact on the fiscal position, however, is common sense: if we are running a deficit of nearly 3 per cent of GDP at the top of the boom, what on earth is it going to be at the bottom of a slump? In the early 1990s the deficit hit nearly 7 per cent of GDP. I don't think we could get there, but we could get to 4 per cent plus.
So what is to give? Yes, the Government will have to borrow a lot more both this year and next, and no messing about with the fiscal rules will alter that. The issue is whether it will also have to do something on spending and taxation. Tax on families is not that high by historical standards, though it has been rising of late. However, we can see how much political resistance there is to higher taxation, and how effective it is, from the climbdowns on the 10 per cent rate and on fuel duties. So this Government cannot do anything on tax.
Spending? It is very difficult. The time to have been trimming spending was between 2003 and 2006, when revenues kept coming in under budget and the deficit failed to decline as planned. Now there could be some modest trimming, as public investment seems to be running over budget. However, you don't want to do anything that reduces overall demand at a time like this.
Let's lighten the gloom by looking at the overall level of public net debt – what we think of as the national debt. We will breach a rule and debt will go over 40 per cent of GDP, but by international standards that is not bad at all. As you can see from the final graph, we were way above it when Labour came to power, though the numbers then were getting better, whereas now they are getting worse. There will be a long slog over the next decade or so getting the deficit back down. As a result, the rise in our standard of living will be lower than it otherwise would have been. But it is not a dreadful problem, either by past UK standards or by the standards of other countries. It is just a shame that we should have made the same mistake again: not being sufficiently disciplined in our fiscal policy.
And of course it is a big personal blow for Gordon Brown. He came into office determined not to make the same mistakes as his predecessors – not to return to boom and bust. So he invented the two fiscal rules: the "golden rule" that governments should only borrow for investment over the economic cycle, and the "sustainable investment rule" that debt should be below 40 per cent of GDP. Then, under the pressure of office and buoyed I suppose by his own rigidity and ambition, he twisted and trimmed the timing of the economic cycle and the classification of investment, so that he broke the spirit, if not the letter, of his own rules. As he must know, he ended up making the same mistake as the previous chancellors whom he so despised.
I don't actually care how the Treasury reforms these rules. It leaked the plan to do so last week, at the start of the parliamentary recess, because it knows it is better to fess up now than when people are back from their holidays. But this is a huge constitutional problem that cannot be fixed by this Government – the next lot will have to sort it out.
Can Asia's success story be applied to Africa?
Some good news and some bad from the world's poorest countries. The general picture of economic progress over the past two decades has been one of declining inequality between the developed world and the developing world as a whole, but increasing inequality within both developed and developing nations. But there is a further twist. The position of the very poorest countries has fallen, as they have not benefited from the advances made by the somewhat richer ones. In a nutshell, Asia has made huge advances but much of Africa has fallen further behind.
Now the UNCTAD Least Developed Countries Report 2008, just out, adds a further insight. It looks at the 50 poorest countries in the world, many of which seem to have benefited from the commodity boom. They had their highest rates of growth in 30 years in 2004 to 2006, even higher than the 7 per cent target set by their governments and the international agencies, with their exports overall rising by 80 per cent. At one level this is encouraging –much better that they should get more from exports rather than less. But the advance has come at a price because their dependence on exports of primary goods – minerals, raw materials and the like – has risen too. So as and when the commodity boom subsides, they will be particularly vulnerable.
There are further problems. The 50 nations studied are very different. Some are mineral producers but others are subsistence agricultural producers, which don't have significant export opportunities and may be food importers. They have seen their position get much worse as food prices have soared.
So what are the lessons? The report notes the need for further debt relief, more inward investment, measures to broaden the economic base and so on. This is all sensible. But the element I would like to see more of is the extent to which the lessons of success in China and India could be spread more widely in Africa. Still, UNCTAD deserves attention for noting just how much needs to be done, despite the encouraging growth numbers.
