Those deficit reduction plans revisited
November 28, 2011
The following article was written by Mark for today’s Telegraph:
It was not supposed to be like this.
Only twelve months ago we were assured that the government’s spending plans for the entire parliament had been conclusively settled. Instead George Osborne will attempt with tomorrow’s Autumn Statement to kick-start UK economic growth beyond its recent anaemic levels. Not that the Chancellor will admit his admirable strategy for deficit reduction has already been blown off course. But it has – as confirmed by his Downing Street neighbour last week.
So whilst Plan A notionally stands intact, lest the markets take fright, we are likely to see the Chancellor present an aggressive series of initiatives promoting industrial intervention and enhancing growth on a scale not witnessed since the 1970s.
If there was a problem with the UK government’s goal of wiping out the structural deficit in this parliament it was that it relied on some highly optimistic assumptions. There have been three main planks to the UK government’s deficit reduction plan.
First, continued low interest rates. This has been the big success story of the past year. Indeed the cost of servicing the UK government’s borrowing has been lower than the Chancellor hoped last autumn.
Nevertheless the astonishing low interest rates on UK gilts in the bond market may prove a temporary phenomenon. I suspect that Chinese and Middle Eastern sovereign wealth funds would be investing in corporate growth if they could find such a thing in UK Plc. Instead by investing their vast surpluses into government debt, the cost of UK gilts has been depressed since the Eurozone travails make us a (relatively) safe haven. For now…
This is good news as the US, UK and German governments service their huge, and growing, borrowings. But is this really sustainable? UK ten-year bonds are currently priced at just above 2%. This is at a time of above 5% inflation – in short the institutions buying our bonds are doing so at negative real interests. Common sense, yet alone economic theory, suggests this is an unsustainable bubble. In the meantime I fear that the UK government and its debt-laden electors are being lulled into a desperately dangerous sense of security.
This comes at some cost, however, for if we persist in keeping interest rates at near zero we simply delay the commencement of the economic reckoning. The sombre truth is that for so long as the Bank of England maintains a virtually zero interest rate policy, the economy remains on a taxpayer-induced life support machine. Our underlying economic problems remain parked, rather than solved. This is only delaying the point at which sustainable economic recovery can commence.
In truth, the continued failure to raise rates is an implicit recognition by the Bank of the underlying weaknesses of UK plc after four years of patchy or negative growth.
The second element of the UK government deficit reduction involves its much vaunted austerity programme – reducing public expenditure from its boom-time levels with a relative squeeze in public spending not seen since the 1920s.
The Coalition plan to eliminate the structural deficit requires the gap between revenue and expenditure to be narrowed by £159 billion in 2014/15. Tax rises are expected to contribute £31 billion and spending cuts £44 billion to this total. However, the economic costs of unemployment, which has risen more quickly and to markedly higher levels than envisaged at last year’s spending review, have already upset this equation. It is clear that the assumption that UK unemployment would peak in 2010-11 has already been surpassed by events.
In view of the increasing public disquiet about perceived ‘savage cuts in public spending’ the government risks the worst of all worlds – receiving relentless criticism for harsh austerity measures, and at the same time failing to follow through with the political will to execute the necessary level of savings. The facts are stark. Over the past 12 months UK government current spending has totalled £613.5bn – the highest figure in history. Borrowing this year is likely to be around £125bn – the coalition’s ‘austerity plan’ means we are all now borrowing £1 in every £5 we spend collectively rather than £1 in every £4 that UK taxpayers borrowed in 2009. In truth we are digging that cumulative debt hole just a little less slowly than before.
Small wonder that so much now rests on achieving the third pillar of the deficit reduction plan – growth. Indeed £83bn of that planned deficit reduction hinges upon achieving sustained economic growth for the term of this parliament. This was predicated in June 2010 on the basis the UK would achieve compound growth of 2.7% for each of the next five years. By contrast, most commentators will be pleasantly surprised if growth in either 2011 or 2012 reaches one-third of that figure.
Moreover, one of the biggest challenges that the Coalition government faces in getting growth on track is that over the past decade and a half roughly three-fifths of domestic expansion in the economy has arisen courtesy of either financial services, the public sector or in the property/construction field. These are three activities in which the present squeeze will be most profound (notwithstanding the recent announcement to provide an adrenalin rush to the first-time buyer housing market), especially as these areas have been largely funded by borrowing. Yet if we discount these key drivers of the last boom it is difficult to predict the type of economic activity in which the necessary super-charged levels of growth can be achieved in future.
The anxiety now for the Treasury is that plummeting levels of business confidence accompanied by the ongoing stagnation and drift in the Eurozone will awaken the markets to some harsh realities.
It will prove mighty difficult to sustain our ‘safe haven’ status if spending and the overall public debt continue rising inexorably. Only the restoration of the UK’s reputation as an outward-looking trading nation, unashamedly ‘open for business’ can save Plan A now.