Andrew Lilico is Policy Exchange's Chief Economist.
Alistair
Darling’s pre-Budget report (PBR) today was a disappointment, though perhaps
not an unexpected one. In particular, it
contained no plan to cut spending further or earlier.
Indeed, spending is rising this year by £5bn, and current spending is
rising faster (0.8%) than projected in the Budget (0.7%). The Government is now relying upon inflation
to do the work of spending control.
There is no
plan to cut the deficit faster. This is
projected to reach 5.5% of GDP in 2013/14 - exactly the same as in the
Budget. The plan is for the deficit to
fall to 4.4% of GDP by 2014/15. In
today's terms, that would be £62bn - a larger deficit than the UK had ever experienced up to 2008/9, even after an entire Parliament of fiscal consolidation.
The PBR boasts (at B.30) that "Cyclically-adjusted borrowing is lower
than at Budget across the medium-term forecast." But this is entirely because of a
redefinition of the cycle, not because of any reduction in the deficit!
In the
meantime, the UK is projected to be borrowing around £175bn in 2009/10 and
2010/11. At 12.5 % of GDP, this is far
in excess of any plausible level at which deficits could be expected to
stimulate the economy in the short-term, assisting it through recession. Instead, a deficit on this scale acts as an
anchor on the economy, raising interest rates and creating concerns amongst
households that their taxes will rise.
The structural deficit (that bit of the deficit that won’t go away as
the economy recovers) is estimated at 9% of GDP, some £125bn (down slightly on
the 9.8% figure estimated at the Budget, but only because of a slightly changed
assessment of the cycle).
Taxes are indeed
projected to reach 37.3% of GDP in 2011/12, a figure not seen in the UK since
1985/6. Indeed, taxes not been above 37%
of GDP since 1986/7. Recent Treasury
research suggests that there is some 1.7m of suppressed unemployment, with
workers keeping their jobs only because they were willing to accept reductions
in hours, pay freezes, or pay cuts. (Our
own research puts the number at above 1.9m.)
Yet the PBR increases employer and employee NICs. Imposing such a tax on employment at this
time could well tip matters over the edge for a significant number of these
people, accelerating what will, anyway, be a significant rise in unemployment
over the next year.
At 4.75%
contraction, 2009 is the worst year for the UK economy since comparable records
began in 1948. Indeed, it is worse than
the likely estimate for 1931 (4.6% contraction). As regards the forwards-looking estimates, to
get growth of 1-1.5% for 2010, the economy would need quarterly expansions of
some 0.4-0.5 throughout 2010. I believe
there will be two quarters of contraction, and GDP will be much closer to flat
on the year, but 0.4-0.5% growth per quarter is certainly not out of the
question. To get 3-3.5% growth in 2011,
the quarterly expansion would have to be around 0.9-1.0%. I believe that’s comfortably doable, albeit at
the cost of high inflation.
Some
commentators seem to be suggesting that if there is growth of 1.25% in 2010,
then Darling’s 2009 Budget growth forecasts will have been vindicated. That is a somewhat confused idea. The 2009 Budget forecast growth in 2009 at
minus 3.5% and plus 1.25% in 2010. Since
the actual contraction in 2009 was 4.75%, the economy starts about 1.25%
smaller at the beginning of 2010. So if
it grows only the 1.25% the 2009 Budget projected, it will be about 1.25%
smaller in 2010 than the Budget thought it would be. That means lower wages, less employment, lower
tax receipts.
There is a
special freeze on the higher rate threshold for 2012/13. I think we can safely say that Darling does
not anticipate deflation in that year. I
think it’s pretty clear that the Treasury expects high inflation that year (as
do I), so that a freeze that year will be a significant money-spinner. The PBR forecasts RPI inflation of 3.5%. I think they must believe it will be higher
(I expect 10%).
Overall,
with rating agency and gilt-purchaser warnings about the UK’s credit status ringing
all around, it is clear now that the UK's ability to borrow and its credit
rating now rely upon bond market expectations that the real decisions will be
taken after the General Election. We’d
better hope that whoever wins will be up to taking them.
