Stephen King: Darling's poison pill for his political foes

David Cameron may be licking his lips at the thought of a return to Conservative rule but, after yesterday's Budget bombshells, he'd be wise to heed some lessons from history. For the Tories, a poisoned chalice awaits.

Some governments are lucky. They're elected after all the hard fiscal consolidation work has been done by others. The Conservatives won the 1951 election following years of fiscal austerity delivered by Clement Attlee's post-war Labour administration. TheTories then stayed in power for the next 13 years. In 1997, Labour inherited a remarkably healthy fiscal position from the outgoing Conservatives. Twelve years later, Labour are still in power.

Other governments are not so lucky. Labour was re-elected in 1974 following the Conservative "Barber boom" of the early-1970s and the 1973 oil price shock. Harold Wilson's government inherited a particularly poor fiscal position and, in the process of trying to bring it under control, lost all semblance of economic credibility. The UK economy had to be bailed out by the IMF in 1976. The Winter of Discontent struck at the end of 1978 and Labour was booted out of office in 1979. Although, by then, Dennis Healey had already adopted many of the policies which later became associated with Thatcherism – rejection of simple Keynesian demand management, and the acceptance of monetary targeting – Labour were going nowhere.

The fiscal numbers outlined yesterday by the Chancellor make for hideous reading. Borrowing in the coming financial year of £175bn is almost unimaginably large. Expressed as a share of national income, though, the numbers are even worse. On the Treasury's projections, borrowing will rise to 12.4 per cent of GDP.

The numbers remain as bad in the following fiscal year and, thereafter, only begin to improve as a result of an assumed (and remarkable) 3.25 per cent growth rate in every fiscal year from 2011 through to 2013.

The rise in the top rate of tax may grab all the political headlines but, in the context of Mr Darling's fiscal projections, its impact is no more than a rounding error. To bring the finances back under control, a lot more heavy lifting will be required.

Under current plans, the level of government debt continues to rise in the outer years of the Treasury's projections notwithstanding the reduction in government borrowing.

The austerity of the late-1940s started when borrowing was a little over 6 per cent of GDP, a legacy of the War. The Labour administration of the mid-1970s also had to deal with a deficit of above 6 per cent of GDP. After reaching 8 per cent of GDP in the early-1990s, the Tories were left to clear up their own mess having unexpectedly won the 1992 election.

With the exception of the Thatcher administration in the early-1980s, governments which have had to impose fiscal discipline after years of recklessness have typically ended up paying a heavy price. So if the Tories win the next General Election (as the polls currently suggest) will they find themselves having to raise taxes or cut spending so much that any initial popularity disappears in an instant? And, if so, will they then face the ultimate curse of the fiscal disciplinarian, to be booted out of office after only a single term?

To be fair, it's easier for governments to borrow these days without having to knock on the IMF's door. Government borrowing has also been helped by the credit crunch. Investors who, once upon a time, happily purchased all manner of now-toxic assets have headed for the safety of government bonds. And in an effort to kick-start the financial system, the Bank of England is also now buying gilts via quantitative easing. The biggest budget deficit in living memory is linked with the lowest gilt yields since the 1950s.

The Government is hoping the economy is suffering primarily a cyclical malaise but, buried in the depths of the Budget papers is an assumption that, as a result of the impact of the credit crunch on the nation's capital stock, there may have been a permanent loss of output relative to trend of around 5 per cent between 2007 and 2010.

This, apparently, is a one-off loss which has no impact on the long-term growth rate of the economy, either past or future. A more likely scenario, is that the Government has persistently over-estimated the economy's sustainable speed limit: it has, therefore, been living beyond its – and our – means.If so, getting the fiscal numbers back on track will be very hard work indeed. Brace yourself for a decade of austerity.

Stephen King is managing director of economics at HSBC