Hamish McRae: Fiscal credibility is on a knife edge – and this spring could be nasty indeed

Economic view

It is, in a funny way, easier to see what will happen in two to three years' time than what will happen in the next two to three months.

That applies to the world economy, for in a couple of years' time the recovery will be secure, whereas this coming spring it may hit a nasty wobble. But it applies particularly to the UK economy, and the uncertainties were, if anything, increased by the pre-Budget report last week. The point has been widely made that the report was more a political statement than an economic one.



The politics are discussed elsewhere in this paper, so just one thought on that here. It is that it is strange that Gordon Brown, for it is his decision, should be prepared to set aside all the effort made by John Smith, Tony Blair and himself back in the early 1990s to convince a sceptical electorate and sceptical markets that Labour in office would be financially responsible. John Smith's charm offensive on the City, Tony Blair's commitment to no change in the basic and higher rates of tax, and Gordon Brown's fiscal rules were all designed to embed in everyone's mind that Labour in office would not make the mistakes it had made in the 1970s. Now that entire effort has been blown to bits and a new leader will, in five, 10, 20, or whatever it is years, have to embark on the same journey all over again. It will inevitably be harder next time, given what has happened.



We now have the highest fiscal deficit, relative to GDP, in the world, and a programme to get that deficit under control that is at the limits of the credible. The independent Institute for Fiscal Studies gives the Government a less than even chance of meeting its own deficit reduction plan, a plan that itself will surely have to be tightened. The story that Alistair Darling wanted to correct the deficit more quickly but was overruled by Gordon Brown and Ed Balls was denied by No 10, but it rings right.



Things are now on a knife edge. That is why it is so hard to predict what will happen in the next few months. It may be that we will scramble through to the general election without any financial shock. But it is quite possible that there will be a sudden loss of confidence in our economic management, with a plunge in the pound and a sharp rise in long-term interest rates. If we do get through, it will be because everyone expects that the new government will act swiftly to correct the deficit. If not, it will be because of a new chunk of adverse news (eg, a downgrading of our sovereign debt, or a further deterioration in the deficit), or because there are expectations of a hung parliament.



It is a curious time. The expectation of a change in government means that power has already begun to shift. The Government still has the levers of power in its hand, but nothing much happens when it pulls them. It can do a few things, as we saw this week with its emergency tax on bankers. Just how effective this will be is not at all clear, the danger being that it does raise some little revenue now but at the cost of a much larger loss of revenue in the years ahead. At any rate the civil service is preparing for the transition, as it is constitutionally obliged to do, and it will seek to make that transition as honourably and competently as possible.



If power has started to shift, so too has responsibility. Last week the Tories announced that the former Treasury chief economic adviser Sir Alan Budd would head their new Office for Budget Responsibility and that will give the office, and their approach to fiscal policy, much greater credibility. That may be enough to preserve market order through to the election but this all feels very fragile and I simply don't think it is possible to make any predictions about the spring. I don't like the look of what is happening in Greece, and concern about sovereign risk could spread quite suddenly.



If you look forward two or three years it is all much clearer. We will have begun a period of fiscal consolidation. You can have a debate about the appropriate balance between tax rises and spending cuts. You can argue about the timing of when this process should begin. But there is no question of the scale of the task ahead, as the main graph, from Citigroup, indicates.



The bank has done some calculations on the scale of fiscal consolidation over the next 10 years needed to get debts to 60 per cent of GDP by 2030. You might think this is a pretty unambitious target. For the UK it would be a 10-year slog merely to get our debt down to one-and-half times the level it was two years ago. But look at the scale of the task: cuts in spending and/or tax rises equivalent to 12 per cent of GDP. That is terrible. We are worse than Greece, worse than Ireland, worse than Spain. The only country worse than us is Japan, which has a target of getting debt down to 80 per cent of GDP.



If most of the developed world is in a fiscal mess, note how most of the emerging nations have come through in much better shape, as the right-hand chart shows. Interesting, isn't it, that "new" economies can teach the "old" ones how to manage their finances?



In a couple of years' time we will have begun that task. The deficit cannot be eliminated in the life of one parliament, though there is a genuine debate as to how quickly to try and get it under control. My own feeling is that if you know you have to do something you had better get on with it. The economic models may predict that larger deficits generate more growth. but that has not happened in Japan since the early 1990s or, indeed, here in Britain for the past couple of years. In any case, there are plenty of examples of fiscal consolidation actually triggering a period of sustained growth.



So, before you despair, remember – sharp fiscal squeezes in Canada, Sweden and India in the early 1990s, and in the UK in the early 1980s, all created the basis for sustained rapid growth.



I have been rereading the speech by Manmohan Singh, then the new finance minister of India, when he presented his emergency budget on 24 July, 1991. He started by pointing out that the new government had inherited an economy in deep crisis. The budget deficit was more than 8 per cent of GDP and the current account deficit was 2.5 per cent of GDP. He set out a programme of fiscal responsibility and other reforms that laid the basis for India's subsequent boom. As a result, it looks as though India, unscathed in this downturn, will become the world's third-largest economy after China and the US within 20 years.



This is how he finished his speech. "Sir, I do not minimise the difficulties that lie ahead on the long and arduous journey on which we have embarked. But as Victor Hugo once said, 'No power on Earth can stop an idea whose time has come.' I suggest to this august House that the emergence of India as a major economic power in the world happens to be one such idea. Let the whole world hear it loud and clear. India is now wide awake. We shall prevail. We shall overcome."



Bit different from the sort of stuff we get from Messrs Brown and Darling, isn't it?

Start your day with The Independent, sign up for daily news emails
Arts and Entertainment
Lou Reed distorted the truth about his upbringing, and since his death in 2013, biographers and memoirists have added to the myths
musicThe truth about Lou Reed's upbringing beyond the biographers' and memoirists' myths
News
people
News
Ed Miliband received a warm welcome in Chester
election 2015
Life and Style
Apple CEO Tim Cook announces the Apple Watch during an Apple special even
fashionIs the Apple Watch for you? Well, it depends if you want it for the fitness tech, or for the style
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45,000: SThree: SThree Group have been well e...

Ashdown Group: IT Manager / Development Manager - NW London - £58k + 15% bonus

£50000 - £667000 per annum + excellent benefits : Ashdown Group: IT Manager / ...

Recruitment Genius: Sales Consultant / Telemarketer - OTE £20,000

£13000 - £20000 per annum: Recruitment Genius: Scotland's leading life insuran...

Ashdown Group: Training Programme Manager - City, London

£40000 - £45000 per annum + benefits : Ashdown Group: Training Programme Manag...

Day In a Page

NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders
Heston Blumenthal to cook up a spice odyssey for British astronaut manning the International Space Station

UK's Major Tum to blast off on a spice odyssey

Nothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
John Harrison's 'longitude' clock sets new record - 300 years on

‘Longitude’ clock sets new record - 300 years on

Greenwich horologists celebrate as it keeps to within a second of real time over a 100-day test
Fears in the US of being outgunned in the vital propaganda wars by Russia, China - and even Isis - have prompted a rethink on overseas broadcasters

Let the propaganda wars begin - again

'Accurate, objective, comprehensive': that was Voice of America's creed, but now its masters want it to promote US policy, reports Rupert Cornwell
Why Japan's incredible long-distance runners will never win the London Marathon

Japan's incredible long-distance runners

Every year, Japanese long-distance runners post some of the world's fastest times – yet, come next weekend, not a single elite competitor from the country will be at the London Marathon
Why does Tom Drury remain the greatest writer you've never heard of?

Tom Drury: The quiet American

His debut was considered one of the finest novels of the past 50 years, and he is every bit the equal of his contemporaries, Jonathan Franzen, Dave Eggers and David Foster Wallace
You should judge a person by how they peel a potato

You should judge a person by how they peel a potato

Dave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
Beige is back: The drab car colours of the 1970s are proving popular again

Beige to the future

Flares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
Bill Granger recipes: Our chef's dishes highlight the delicate essence of fresh cheeses

Bill Granger cooks with fresh cheeses

More delicate on the palate, milder, fresh cheeses can also be kinder to the waistline
Aston Villa vs Liverpool: 'This FA Cup run has been wonderful,' says veteran Shay Given

Shay Given: 'This FA Cup run has been wonderful'

The Villa keeper has been overlooked for a long time and has unhappy memories of the national stadium – but he is savouring his chance to play at Wembley
Timeless drama of Championship race in league of its own - Michael Calvin

Michael Calvin's Last Word

Timeless drama of Championship race in league of its own