Hamish McRae: Time to deal with domestic blockages

Economic View

It is of course another Budget on Wednesday and one that the Chancellor should not enjoy delivering, for this was not where we were meant to be. We ought by now to be halfway through the coalition's deficit- cutting programme and we are only one third of the way through.

Not good; and made all the worse by the slight slippage this year, for after you make all the adjustments, it looks as though the underlying deficit this financial year will be no lower than it was last.

So we are stuck. There is no point in getting bogged down with the detail here, for there will be plenty of that later. What I think is worth doing is setting out where we are now and what we are doing in the global context – to catch some sort of feeling as to how much longer the present trudge lasts and how steep the path ahead is likely to be.

If you look back there are not many budgets that stand out. There are a few: the 1981 one of Sir Geoffrey Howe, when he tightened policy in the face of the recession; the 1988 budget of Nigel Lawson, which cut the top rate of income tax to 40 per cent, a change that sharply increased the amount of tax paid by top earners; the 1997 budget of Gordon Brown, which set out his golden rule to borrow only for investment, and the parallel decision of giving the Bank of England power to set interest rates; and the present coalition's programme of 2010.

There are individual programmes that have achieved lasting resonance, such as the creation of ISAs, but most of the stuff is swiftly forgotten or overturned in subsequent decisions. Take for example the way in which pension rules and allowances have been chopped and changed from year to year. Set against this background, there are two broad areas of interest this week.

One will be the progress along the multi-coloured path of the main graph. It comes from the December report of the Office for Budget Responsibility and shows its best estimate for the progress towards a balanced budget.

Ignore the kink because that is the result of the reclassification of the Post Office's pension fund and you can see that we are trying to get down to a deficit of around 2 per cent of GDP by 2018. If that sounds a long way off, note that Germany is there already. In fact it has done better as it is close to balancing its budget now.

So there is a long, long way to go. Anyone who wants to attack the coalition for cutting the deficit too fast should be aware that, with the possible exception of Japan, we are cutting more slowly than any other large economy. This is not politics; it is maths.

Whether we are heading a bit below the back centre point (ie correcting the deficit faster than the OBR central expectation) or a bit above it (correcting more slowly) is important. But it is not nearly as important as the basic truth that we have to keep trying to get the numbers down.

How painful that will be will depend on growth. Have a look at the right-hand graph, which I find quite startling. It shows what has been happening to retail sales in the US and Europe.

As you can see sales dipped sharply in both regions in 2008, but in the US they recovered whereas in Europe they went on down. The UK (not shown) would be in between, for as so often our economy behaves as a mid-Atlantic one. On one particular measure, car sales, we are doing well, as we are the only major market in Europe where numbers are going up, not down.

But if Europe remains very depressed, it will inevitably be hard for the UK to show much growth, for while the US is our largest single export market, the eurozone taken as a whole still accounts for some 45 per cent of merchandise exports.

There are some signs that the outlook for the eurozone is improving, but I am afraid that red line is not going to perk up much this year, and probably not much next. So the burden of keeping the economy growing will depend largely on home demand. What can be done about that?

That switches attention to the second thing to look for on Wednesday: any hints as to ways in which the blockages to increased domestic demand are likely to be, well, unblocked. That is a monetary and financial issue, not a fiscal one, and we will have a new Governor of the Bank of England whose job it will be to help improve the functioning of the financial system. Will Mark Carney be Mr Dyno-Rod?

Two people in the past week have given me rather similar explanations of the problem. One was the head of one of our largest pension funds, who felt that we had to find a way of getting purchasing power into the hands of middle and lower-income people. He felt that there was a case for a cut in VAT, a policy incidentally advocated by Labour.

The other person was a London taxi driver, who put the problem more succinctly: "The trouble," he said, "is that the people who have the money don't want to spend it, and the people who want to spend it don't have the money."

Yes, indeed. Unfortunately, we had arrived by then and I didn't get his solution. My own feeling is that the problem is more monetary than fiscal. Or put another way, the solution of unblocking financial flows, so that creditworthy borrowers can get the money that is at present sitting around doing nothing or going into gilts, is a more appropriate one than any fiscal measures.

And that, I suggest, will be the main thing to look for this week. We won't get detail because budgets are about fiscal policy, not monetary policy, and in any case it would be sensible to wait until Mark Carney is in the post. But there are things to be done and the sooner the better.

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