US balances while British deficit burns
Tuesday 21 November 1995
It is always difficult for the markets to hit it right on day one, for second thoughts are usually better than knee-jerk reactions. Nevertheless, the positive response to the US budget deal shouts that this is pretty near the top end of the range of expectations. It charted a clearer path to the balanced budget than had been expected, and more important, one that might actually be followed.
If that is right, and it will be a year or two before we know for sure, the US has established a new global standard. Governments around the world will have to show some credible path towards a balanced budget if they wish to borrow on half-reasonable terms. The US government already borrows at lower real interest rates than any other large industrial country, with the possible exception of Japan. Stir in a dash of fiscal responsibility and this begins to become a significant comparative advantage, not so much for the government itself and for its taxpayers, but for the business community as a whole.
The lower the real interest rate at which the state can borrow, the lower the real interest rates at which companies can borrow. Sure, giant multinationals will simply raise funds in which- ever market will do the best deal and in whichever currency suits, so this will confer little comparative advantage to large US-based corporations. But further down the scale, companies that do not have access to international markets, cheap money will matter. Just wait.
Here in Britain we are in the final glide-path to the Budget. There have been the usual clutch of stories about the size of the net tax "give-away" to expect in a week's time, with the original pounds 2bn figure creeping up towards the pounds 4bn mark, notwithstanding the undershoot on the revenue side.
In the last couple of days the evidence of slower-than-thought growth in the second quarter, and a better-than-expected retail price performance has led to the idea that it will somehow be easier for the Chancellor to justify larger tax cuts. Note that there has hardly been any comment about the impact on the deficit, except in the general terms of a rise being acceptable to the markets.
As for the Government's official position on borrowing, it remains the general one that the objective is to balance the budget over the medium- term economic cycle. But no one seriously believes that, were the Tories to be re-elected, the budget would be balanced (ie surpluses would match deficits) over the next five or 10 years. The stated policy is therefore meaningless.
Meanwhile, from Labour there is this new (and in its own terms perfectly sensible) plan to soften the entry into the income tax threshold by bringing in the new 10 per cent starting rate. But there is nothing about the much more important issue of the proposed fiscal stance. Would a Labour government seek some limit on its power to borrow? Does it have any view about the morality of borrowing, given that a deficit is deferred taxation?
In other words, the discussion we are seeing in Britain, in the run-up to our Budget, is on a quite different plane to that in the US, where the common ground has been the need for fiscal restraint, and the main discussion about alternative paths to virtue. I suspect that in another five years the sort of debate we are having here will seem as antique as the British budget debates of the 1950s and 1960s, when there was endless argy-bargy about "the fiscal judgement": how much "demand" the Chancellor ought to "inject" into the economy.
So what happens next? I don't think anything will happen ahead of the election. We will have this Budget, and it will be discussed by most people in the usual shrill, politicised way. We may or may not have another Tory Budget, for it is not clear that the present Government will make it to November next year. But after the election I think the tone of the debate will alter, for two reasons.
Firstly, within the European Union we will be getting close enough to the official start date for European Monetary Union that the Maastricht conditions will be dragging deficits below the 3 per cent of GDP level. Individual countries may or may not make it, but everyone will be talking about fiscal deficits in a new and more aggressive way.
Second, and more important, the new world standard will start to assert itself. Markets will want to see some progress towards the balanced budget, even if that progress is pretty token, just as they want to see some progress towards an independent central bank.
Together these forces will exert a pincer movement on deficits: politics (at least within the EU) and markets will be converging on the same point. Result: a sea change in the way public-sector deficits are regarded.
Expect British politicians to catch up, with voices from both political parties pressing for deficit reduction, on the grounds of equity as much as efficiency. What is difficult to see at the moment is whether the voices will be stronger from the left or the right. That may depend on the result of the election, for it is self-evidently easier for the out-of-office lot to call for a balanced budget than for the ones in power to deliver it.
But that is all to play for. Meanwhile, reflect on the narrowness of the current debate. A starting rate of income tax at 10p in the pound is a sideshow. A bigger battle is on the way.
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