Budget deficit biggest threat to recovery
WE are in danger of getting blasé when it comes to Britain’s disastrous public finances. Yesterday’s figures were truly shocking; the monthly deficit total is now close to what we used to get for a whole year. It is fortunate for Gordon Brown that Sir Fred Goodwin’s decision to repay part of his pension and the MPs’ expenses scandal knocked the story off today’s front pages. There can be no doubt that the state of the public finances poses the greatest medium-term threat to the recovery; while we are now out of a technical recession, a drastic fiscal squeeze is inevitable and will start in a year or so, threatening to push us back into contraction or at least guarantee years of stagnant national income.
Public sector net borrowing surged from £12.2bn in May last year to £19.9bn last month, the largest borrowing figure on record. The budget deficit will probably hit £200bn, or 14 per cent of GDP, this year. This astonishing gap between spending and revenues can largely be explained by the fact that central government receipts collapsed by 10.8 per cent from last year and current expenditure shot up by 7.4 per cent. To blame was a collapse in output over the past year, decimated corporate profitability, surging unemployment, lower bonuses and in some cases even wages, rocketing welfare benefits, the 15 per cent rate of VAT, a much reduced number of housing transactions and lower property prices.
For all the government’s absurd pretence that is it incurring a massive deficit on purpose, as part of a cleverly thought out Keynesian boost to demand, this is a catastrophe. One of Brown’s infamous fiscal rules was that net debt would be kept to 40 per cent of GDP; yet at the end of May it had reached £774.8bn, or 54.7 per cent of GDP. This compares to £629.0bn (43.6 per cent) as at the end of May 2008. The entire rules-based economic policymaking of the past 12 years now lies in tatters; there is nothing left to salvage.
There is an important theory in economics which goes by the rather dry name of Ricardian Equivalence. This states that Keynesian-style intervention in the economy doesn’t work as consumers and firms know that they will eventually be hit by huge tax hikes to pay for all the expenditure. So the private sector tends to cut back when it realises that the government is spending too much – or at least, so the Ricardians would argue. There was much scepticism from mainstream economists about this in recent years but all of the evidence now seems to support the theory, at least in exceptional situations such as the present fiasco.
All of us, as consumers, investors or decision-makers, fear that taxes will go up, with good reason; even the Tories, should they be elected next year, will be tempted to pick our wallets rather than risk the wrath of the public sector unions by taking a chainsaw to public spending. So it makes sense for consumers to batten down the hatches, pay down their debts and save as much as possible before the tax hikes begin to hit. No wonder retail sales were down in May.
With more and more consumers beginning to factor in a sharp reduction in their take-home pay, only a credible, well explained and unashamedly non-Keynesian policy of radical cuts to public spending could now rescue the economy.