Hamish McRae: The biggest poser for the new Government: where will the growth come from?

Economic Life: Policymakers assumed that the tax boost was the result of an improved structural growth rate, whereas it was the result of an unsustainable cyclical boom

If fiscal austerity has become the "new normal" across Europe, might slow growth be its partner? The best way to starting trying to think through the process that begins with the emergency Budget promised within 50 days is to separate the cyclical from the structural. We have had a boom and a slump. Now we are going to have, not a boom, but an increasingly solid recovery, starting probably next year.

We should not rule out the possibility of a double dip to the recession, for that would be completely normal, but I think by the end of next year the growth numbers should look quite strong. We need it. We are not in the position of Greece, which many of us think has accumulated debts that can never be repaid in full. But our ability both to service a doubled national debt, and to start to repay it, will turn on our ability to generate growth. If it is a problem for us, it is also a problem in even greater measure for much of Continental Europe, where relative debt levels are generally higher and growth prospects on balance probably worse. But that is bad news too: we still sell a lot of stuff there.

So we are about to begin along a difficult path, and it is worth just making it clear why we are where we are. In a nutshell, our policy-makers confused the cyclical with the structural. They assumed that the strong boost to tax revenues during the boom years was the result of an improved structural growth rate, whereas actually it was the result of an unsustainable cyclical boom.

I have been looking at some work by Dr Bill Martin, a former City economist now at the Centre for Business Research at Cambridge University, which shows what would have happened to the deficit and to our debt had there not been these bubble years.

You can catch a feeling for this from the graphs. The blue lines show the actual deficit as published, the red line what the econometric model he has developed shows would have happened had growth been on a more sustainable path. As you can see, our "real" deficit never went into surplus during the 1999/2001 dip, and reached 5 per cent of GDP in 2005. Indeed during the long growth period between 2002 and 2007 we were above the Maastricht limit, whereas on the official figures were we on it or below it.

As a result, our national debt, far from dipping down to below 35 per cent of GDP as reported at the time, was really only briefly below Mr Brown's 40 per cent ceiling, and actually by 2007 – ie, well before the recession struck – was already approaching 50 per cent of GDP.

The point about this bit of history is that it shows that a cyclical boom can conceal a longer-term trend. So the question now, as the cycle moved into some sort of upswing, will be the extent to which the cycle will help us get our finances under control and the extent to which, on the other hand, the structural debt burden will hold back the cyclical advance.

This is a huge problem for the rest of Europe, too. The point was well put yesterday by Mohamed El-Erian, the chief executive officer of Pimco, a US fund manager:

"What is happening in Europe is a vivid illustration of an underlying theme of the new normal," he said. "There are structural forces overwhelming traditional cyclical ones."

Pimco believes that the debt crisis in Europe reinforces its view that there will be an extended period of below-average economic growth, even after global markets have rebounded from the financial crisis.

That seems to me to be the biggest threat to our new government. We simply won't get the growth. The reason will not so much be the fiscal drag from the need to correct the deficit. When a deficit is obviously unsustainable, as ours is, it has probably stopped giving any boost to the economy. The caution, even fear, induced by a double-digit deficit more than offsets the extra money being spent. We have to rebalance our economy and that is that. The reason is simply that it is hard to see where demand will come from. Consumers will be hit by rising taxation; most of our export markets are also likely to experience slow growth; companies will be reluctant to hire; and so on.

I have a further worry: the underlying public finances may be even worse than the present numbers suggest. There is evidence that the Revenue and Customs have been delaying tax repayments, while pushing harder to get unpaid tax in. Some capital gains tax gains will have been taken in recent months to avoid the higher taxes to come. Income tax receipts may actually fall as people cut their income as the 50 per cent tax rate comes in. Governments can put up tax rates, and this one will, but the revenues may not rise in line with the higher rates.

All this will be scrutinised by the new Office for Fiscal Responsibility, headed by Sir Alan Budd. So there will be some external verification of Treasury forecasts.

I should make it clear that once Alistair Darling was installed as Chancellor, the Treasury's assessment of the future trend of government finances improved markedly. We at last started to get robust figures rather than overly optimistic ones. I expect when the final borrowing outcome for the past financial year is revealed it will turn out to be a little worse than the £167 billion currently quoted, but only a little. The Treasury may now overestimate its ability to get the tax revenues in.

So what should we look for in the coming 50 or so days before the next Budget? Three things. First, any evidence about the buoyancy or otherwise of the economy, for growth is crucial. So we should hope for positive signs from business surveys here and elsewhere, signals from the housing market and from the consumer confidence surveys, any early news on hiring intentions in the private sector and so on.

Second, in their incoherent way, the financial markets will try and give a feeling for the solidity or otherwise of the world economy. Markets seem to have got over their Greek scare, though the medium-term outlook for heavily borrowed eurozone countries is dire. Remember that nearly three-quarters of the earnings of FTSE 100 companies comes from overseas, either in remitted profits or export receipts, so that gives a picture of the health of the world economy. If the world economy continues to recover it will pull us along with it.

And third, we should use our heads to observe how we as ordinary people are responding to the new political landscape. Are we going to be more cautious or more relaxed? Are we going to accept austerity, or are we likely to take to the streets?

I suppose what worries me most is not the reaction over the next few months, but the sense of having been cheated – of having been made financial promises that cannot be kept – that will last for years. We have to get growth going again, and a sullen electorate will find it hard to deliver that – which of course makes the deficit even harder to crack.

h.mcrae@independent.co.uk

Suggested Topics
News
Susan Sarandon described David Bowie as
peopleSusan Sarandon reveals more on her David Bowie romance
Sport
Arsenal supporters gather for a recent ‘fan party’ in New Jersey
football
Sport
sportDidier Drogba returns to Chelsea on one-year deal
Arts and Entertainment
The Secret Cinema performance of Back to the Future has been cancelled again
film
PROMOTED VIDEO
Life and Style
Balmain's autumn/winter 2014 campaign, shot by Mario Sorrenti and featuring Binx Walton, Cara Delevingne, Jourdan Dunn, Ysaunny Brito, Issa Lish and Kayla Scott
fashionHow Olivier Rousteing is revitalising the house of Balmain
News
people
Arts and Entertainment
Christian Grey cradles Ana in the Fifty Shades of Grey film
filmFifty Shades of Grey trailer provokes moral outrage in US
News
BBC broadcaster and presenter Evan Davis, who will be taking over from Jeremy Paxman on Newsnight
peopleForget Paxman - what will Evan Davis be like on Newsnight?
Life and Style
fashionCustomer complained about the visibly protruding ribs
Voices
The new dawn heralded by George Osborne has yet to rise
voicesJames Moore: As the Tories rub their hands together, the average voter will be asking why they're not getting a piece of the action
Sport
Dejan Lovren celebrates scoring for Southampton although the goal was later credited to Adam Lallana
sport
News
newsComedy club forced to apologise as maggots eating a dead pigeon fall out of air-conditioning
Arts and Entertainment
Jo Brand says she's mellowed a lot
tvJo Brand says shows encourage people to laugh at the vulnerable
Life and Style
People may feel that they're procrastinating by watching TV in the evening
life
News
ebookA unique anthology of reporting and analysis of a crucial period of history
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

Senior Risk Manager - Banking - London - £650

£600 - £650 per day: Orgtel: Conduct Risk Liaison Manager - Banking - London -...

The benefits of being in Recruitment at SThree...

£18000 - £23000 per annum + Comission: SThree: SThree, International Recruitme...

Test Analyst - UAT - Credit Risk

£280 - £300 per day + competitive: Orgtel: Test Analyst, Edinburgh, Credit Ris...

Trainee Recruitment Consultants - Banking & Finance

£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

Day In a Page

Evan Davis: The BBC’s wolf in sheep’s clothing to take over at Newsnight

The BBC’s wolf in sheep’s clothing

What will Evan Davis be like on Newsnight?
Finding the names for America’s shame: What happens to the immigrants crossing the US-Mexico border without documents who never make it past the Arizona desert?

Finding the names for America’s shame

The immigrants crossing the US-Mexico border without documents who never make it past the Arizona desert
Inside a church for Born Again Christians: Speaking to God in a Manchester multiplex

Inside a church for Born Again Christians

As Britain's Anglican church struggles to establish its modern identity, one branch of Christianity is booming
Rihanna, Kim Kardashian and me: How Olivier Rousteing is revitalising the house of Balmain

Olivier Rousteing is revitalising the house of Balmain

Parisian couturier Pierre Balmain made his name dressing the mid-century jet set. Today, Olivier Rousteing – heir to the house Pierre built – is celebrating their 21st-century equivalents. The result? Nothing short of Balmania
Cancer, cardiac arrest, HIV and homelessness - and he's only 39

Incredible survival story of David Tovey

Tovey went from cooking for the Queen to rifling through bins for his supper. His is a startling story of endurance against the odds – and of a social safety net failing at every turn
Backhanders, bribery and abuses of power have soared in China as economy surges

Bribery and abuses of power soar in China

The bribery is fuelled by the surge in China's economy but the rules of corruption are subtle and unspoken, finds Evan Osnos, as he learns the dark arts from a master
Commonwealth Games 2014: Highland terriers stole the show at the opening ceremony

Highland terriers steal the show at opening ceremony

Gillian Orr explores why a dog loved by film stars and presidents is finally having its day
German art world rocked as artists use renowned fat sculpture to distil schnapps

Brewing the fat from artwork angers widow of sculptor

Part of Joseph Beuys' 1982 sculpture 'Fettecke' used to distil schnapps
BBC's The Secret History of Our Streets reveals a fascinating window into Britain's past

BBC takes viewers back down memory lane

The Secret History of Our Streets, which returns with three films looking at Scottish streets, is the inverse of Benefits Street - delivering warmth instead of cynicism
Joe, film review: Nicolas Cage delivers an astonishing performance in low budget drama

Nicolas Cage shines in low-budget drama Joe

Cage plays an ex-con in David Gordon Green's independent drama, which has been adapted from a novel by Larry Brown
How to make your own gourmet ice lollies, granitas, slushy cocktails and frozen yoghurt

Make your own ice lollies and frozen yoghurt

Think outside the cool box for this summer's tempting frozen treats
Ford Fiesta is UK's most popular car of all-time, with sales topping 4.1 million since 1976

Fiesta is UK's most popular car of all-time

Sales have topped 4.1 million since 1976. To celebrate this milestone, four Independent writers recall their Fiestas with pride
10 best reed diffusers

Heaven scent: 10 best reed diffusers

Keep your rooms smelling summery and fresh with one of these subtle but distinctive home fragrances that’ll last you months
Commonwealth Games 2014: Female boxers set to compete for first time

Female boxers set to compete at Commonwealth Games for first time

There’s no favourites and with no headguards anything could happen
Five things we’ve learned so far about Manchester United under Louis van Gaal

Five things we’ve learned so far about United under Van Gaal

It’s impossible to avoid the impression that the Dutch manager is playing to the gallery a little