By Neil O'Brien
Yesterday the Institute for Fiscal Studies noted that the government was on course to borrow even more than it expected to. They said that, “If this level of growth in borrowing were to continue for the remaining five months of this financial year, borrowing for the whole of financial year 2009–10 would be about £217bn (or £42bn higher than was forecast in April’s Budget).”
That would mean we are borrowing roughly:
- £818 million a day
- £34 million an hour
- £570,000 a minute
- £9,500 a second.
The interest on all this debt will not be cheap. Soon, 9p in every pound of tax we pay will be spent not on public services, but on servicing debt interest. We will be flushing £50 billion a year down the toilet – more than we spend on schools. That’s real “government waste” for you.
We’ve been carrying out a major research project (which will be published shortly) on international and historical examples of major spending cuts. That lets us put our current debt crisis in context.
Britain’s deficit today is at the very upper limit of anything previously experienced by developed economies. If the Government borrows £217 billion this year, that will be about 15% of GDP.
The biggest deficit reduction we looked at was in Sweden, where the government deficit was improved by 14.8% of GDP (from a deficit of 11% GDP in 1993 to a surplus of +4% in 2000). Roughly half of their deficit problem was solved with spending cuts, and the other half with big increases in tax.
If we followed the Swedish example in Britain, it would mean adding the equivalent of 20p onto the basic rate of tax. Not many people want that.
Only Ireland has really come close to what Britain now needs to do – chopping public spending as a share of GDP by 14% of GDP between 1985 and 1996.
There are two big things we can learn from recent international experiences. Both of them are about growth:
- Sorting out the deficit promotes growth and recovery – particularly by enabling a looser monetary policy than would otherwise have been the case. Some argue that we should put off tackling the deficit until we are deep into recovery. In fact sorting out the deficit actually helps to boost confidence and aids faster recovery. In all six of the international examples we looked at long-term interest rates substantially after the public finances were stabilised - particularly in the two cases we looked at which followed financial crises. In Sweden, successful consolidation halved the interest rates on a ten year government bond from 10% to 5% between 1994 and 1998 and in Finland rates fell from 9% to 5%. That in turn helped them recover.
- The fiscal correction should be biased towards spending cuts to avoid choking off growth. The most successful fiscal consolidations have been those which were biased towards spending cuts, not tax rises. Britain’s first big postwar attempt to shrink its deficit, after the first IMF bailout of 1968, was mostly based on tax rises, and proved unsustainable. In the early 1980s Ireland also initially tried to close its deficit with a programme heavily biased towards tax rises. However, this strategy failed and had to be abandoned in favour of the “Programme for National Recovery” - which was based almost entirely on spending cuts. Our sample of case studies reinforces the conclusion of previous work on this subject by the IMF: “fiscal adjustments which rely primarily on spending cuts on transfers and the government wage bill have a better chance of being successful and are expansionary”.
Is there a light at the end of the tunnel for Britain? Well, other countries have previously dug themselves out of difficulties that are (nearly) as bad as ours. With huge determination, we can get the economy back on track. But we can’t afford to delay for much longer.
