Jeremy Warner: This is more politics than economics – with a sting in the tail
Tuesday 25 November 2008
Now let's see if I've got this right – the Government proposes to address a recession whose origins lie in a credit-fuelled spending binge that left Britons on average more indebted than any other country in the world by encouraging consumers to spend even more and then financing it by borrowing so much that it doubles the national debt. Surely some mistake? Regrettably not. Welcome to the weird and wacky world of reflationary economics – or should that be reflationary politics?
The Chancellor said in his pre-Budget report speech that exceptional times call for exceptional measures, but one thing is certain: the financial crisis has given the Government the perfect excuse for what is possibly the biggest pre-election giveaway the country has ever seen – some £20bn of it, amounting to a full one percentage point of GDP, according to the Chancellor's own estimate.
At the same time, the recession has enabled post-Blair Labour to come fully out of the closet as a party of tax, borrow and spend – that is, borrow and spend now, and then tax high earners later to help pay for it all. Not that it is just the better-off who will be picking up the tab. National insurance for employees and employers will rise across the board, a tax hike which will be worth more than £5bn a year to the Government when implemented the year after next.
Despite these attempts to claw the recessionary giveaway back again, the pre-Budget report reveals what can only be described as an absolutely disastrous deterioration in the public finances. Even on the Treasury's own estimates, which are certain to prove overly optimistic, the fiscal deficit swells to a post-war record of 8 per cent next fiscal year, worse than any of the past three recessions, and just exceeding the previous record set under Norman Lamont in the early 1990s.
In reality, the outturn looks destined to be a good deal worse. In the absence of an unexpected turnaround in confidence and credit conditions, the Chancellor's hopes of a rapid bounce back in economic activity from the second half of next year onwards looks like no more than wishful thinking.
The delayed tax rises will in themselves act as a severe break on economic recovery, making the projected return to above-trend growth of 3 per cent by 2011 seem almost delusional in its thinking. As for the forecast of a return to the sunlit uplands of balanced budgets by 2015-16, even if plausible, it's so far off as to be virtually meaningless. As it is, the assumptions that lie behind it are heroic: a return to sustained 3 per cent-per-annum growth, severe curtailment of the growth in public spending and so on.
In the meantime, all the Government's hard work in bringing public debt as a proportion of GDP down to respectable proportions goes out the window. The debt ratio rises from 43.2 per cent now to 68.6 per cent in 2012-13, requiring a massive increase in issuance of gilts. Appetite for public debt is for the time being high, yet even in a deflationary environment you have to wonder how willing debt markets will be to finance such a stellar rise in Britain's national indebtedness.
In normal circumstances, borrowing on such a scale would be highly inflationary, and therefore require a steep rise in interest rates. In a deflationary environment, it might be possible to raise such amounts at low rates, but it would also crowd out virtually all other investment and thereby greatly restrict the chances of economic recovery. Either way, the consequences scarcely look benign.
The new orthodoxy is that it is better to spend, reflate and worry about the consequences for borrowing, inflation and taxes later, than do nothing and allow the recessionary waves to engulf the economy. The resulting collapse in tax revenues and rise in social security costs might end up costing the Government even more. Yet even if it is right to reflate, it seems questionable that the Government is going about it the right way.
The 2.5 percentage-point reduction in VAT, which accounts for the bulk of the giveaway, will make no difference at all to low and moderately earning households, virtually all of whose disposable income is being eaten up by essentials unaffected by the VAT tax changes. Even on petrol, alcohol and cigarettes, the VAT concession is all clawed back again through a compensating rise in excise duty.
There is a halfway decent package of measures to help small business, but it is completely spoilt by the proposed increase in national insurance and another veritable lorry load of red tape and tax complexity. According to the accountants Ernst & Young, there were 40 separate policy initiatives, mostly to do with taxation, in yesterday's PBR. So much for tax simplicity.
Pensioners and "hard-working families" gain a little, but none of it seems enough to return the economy to rip-roaring growth. In that regard, lower fuel prices and mortgage rates, which are occurring independently of Government action, seem likely to do more than anything ministers announced yesterday.
Only £3bn of the £20bn reflationary boost promised by the Government is made up of capital spending, and even this relates to existing spending plans brought forward from future years. If the Government must borrow recklessly, this is where the money should be applied, not on tax giveaways that will knock a couple of quid off the price of an imported, flat-pack, IKEA bookcase, but on public infrastructure that would provide the nation with long-term economic benefit.
The Government's failure to grab the "opportunity" that recession allows to throw fiscal caution to the winds and spend on transport, power, health and educational works has been passed over in favour of what looks like little more than a pre-election bribe of equally little economic traction. Even on the Chancellor's own forecasts, it is going to take years to clear up the resulting mess. The charge made by the shadow Chancellor, George Osborne, that this was a political, not an economic PBR, looks more than justified.
The resulting build-up of public debt represents a massive liability for future generations of taxpayers that can ultimately only be eradicated by inflating it all away. As it is, the Government will struggle to finance the deficits proposed without crowding out the private sector to such a degree that it becomes emaciated and incapable of its natural process of wealth creation.
The economy won't properly begin growing again until banks stop deleveraging and resume lending. That's not going to happen any time soon, so extreme was the debt overhang created during the boom. The Government's response to this necessary process adjustment merely replaces one form of debt with another and may only prolong, rather than cure, the agony.
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