Deficit may undershoot despite GDP setback

David Smith

Shooting the messenger is never a good idea. Even so, on Friday the Treasury must have thought about getting up a posse and heading down the M4 to the Office for National Statistics in Newport.
Time and again in this recession, the ONS has come up with gloomier gross domestic product numbers than anybody expected. It did so again on Friday. The debate had been whether GDP would be flat or show a small rise. Government and opposition were gearing up for a political spat on what the end of recession meant.

The Bank of England’s monetary policy committee said in its minutes last week that GDP in the third quarter appeared to be in line with its August forecast, which was for a rise of nearly 0.2%.

Instead, we had a 0.4% fall on the quarter, making this the longest continuous period of falling GDP on record, though not yet the longest recession. The official statisticians have proved, at the very least, they are no propaganda machine. Other than that, we should treat these early estimates with a huge pinch of salt because they are so out of line with survey evidence.

In time the GDP figures will be revised but, when they are, it will not be news, merely of interest to number-crunchers. Meanwhile, we have seen some consequences of the weak numbers for sterling, which fell, and in expectations that the Bank will extend its programme of quantitative easing.

What about the public finances? Let me take you back to the recession’s start, and Alistair Darling’s first budget in April 2008. It included a forecast for public borrowing for 2009-10 of £38 billion, 2.5% of gross domestic product. The government’s net debt would remain below 40% of GDP, the official ceiling, through to 2013.

A year later, the picture was shockingly different. The borrowing forecast shot up to £175 billion, 12.4% of GDP. That’s right, borrowing equivalent to 10% of the economy, in a single year, added to Treasury projections in just 12 months. Debt, by the way, is now 59% of GDP and rising.

Treasury officials are working hard on the appetiser for Darling’s third budget, the pre-budget report (PBR), to be released in late November or early December.

It is very significant, not least because many feared another big upward revision of borrowing. That and the absence of new measures could have got the rating agencies sharpening their pencils to downgrade Britain’s AAA sovereign debt rating.

The numbers are not yet complete but the Treasury suggests things are broadly on track to meet the budget forecast. Dave Ramsden, its chief economist, set himself the goal in the budget of not having to revise the borrowing figures up again. It looks as if he may have succeeded.

At least one independent economist thinks the Treasury could go further. Karen Ward, UK economist at HSBC, has gone through the assumptions the Treasury used in doing its forecast in April.

Those assumptions, some of which have to be approved by the National Audit Office, were made at the time of deepest gloom, in March, when shares were low, the oil price was weak, and economists were at their gloomiest about unemployment.

Ward has gone through these assumptions one by one and concluded that there is a small pot of gold for the Treasury in them. The higher stock market, for example, should give the Treasury an extra £3.1 billion of revenue this year, the higher oil price £4.2 billion, lower-than-feared unemployment £1.8 billion, and so on.

The result is that she expects this year’s borrowing to be £153 billion, 10.8% of GDP, more than £20 billion below the Treasury’s forecast, with the improvement running through to future years. Under her projections, cumulative borrowing over the period from 2009-10 to 2013-14 will be £131 billion lower than the Treasury expects.

There are a couple of caveats. The first is that, as Ward points out, these only change the public finances “from appalling to merely very bad”. Most other independent economists still think, moreover, that the risks to borrowing are on the upside.

The second caveat is that I would not expect big revisions from the Treasury in the PBR in either direction. The important part of the borrowing story will not be known until the final months of the fiscal year — January, February and March. The Treasury would not want to revise down now only to have to revise up later.

Even so, the HSBC forecast reminds us it is too easy to fall into the trap of believing things can only ever get worse. The experience of the 1990s, when Britain moved from a budget deficit of 8% of GDP to a surplus of 0.5% in five years should be one that guides us through these dark days.

In the meantime, there is no shortage of ideas for getting the deficit down. My wish is that we should stop expressing every tax change in terms of how many pennies on income tax it would be equivalent to.

The National Institute of Economic and Social Research, for example, said last week that the government could raise the basic rate of income tax by 7p in the pound — which is not going to happen — or bring forward even more the raising of the state pension age, and to aim for 70.

I like the approach of Reform, the think tank, which identifies £31 billion of “middle-class” welfare, including child benefit, tax credits, maternity pay and the state pension, and say half these outlays should be cut immediately, whatever the squeals. Even if the public finances improve, these debates have a long way to run.

PS: How do you solve a problem like Mervyn? For many months intelligent people have been working hard on how to make banks more risk-averse and less prone to excesses. Then along comes the Bank of England governor.

The days of a gentle raising of the eyebrows are gone. These days, though he was in Edinburgh, Mervyn King used a Glasgow kiss, warning that moral hazard in the banking system is worse than ever and that there has been “little real reform” nationally or internationally.

Though speeches like this make great copy, they trouble me. Either King is showboating, which is entirely possible, or he is right out of the policy loop, which is worrying. We are in a pre-election limbo. If The Tories win and transfer banking regulation to the Bank, King would have the opportunity to mould the system, including a bank break-up, in the way he apparently wants. His fear may be that by then it would be too late.

I am not convinced by the argument that we need to break up banks. Britain has a heavily concentrated banking system — too few banks — but a better answer is competition, including international competition, and new entrants. Banks should be restricted from engaging in dangerous, “socially useless” activities, as Lord Turner of the Financial Services Authority suggests.

Paul Volcker, former chairman of the Federal Reserve, now head of Barack Obama’s economic recovery board, knows what he wants. Commercial banks receiving government guarantees should not own or sponsor hedge funds and private-equity funds and their proprietary trading — trading their own funds in the markets — should be restricted.

King, however, is vague. In Commons Treasury committee evidence earlier this year he said “narrow” banks would not work because people would favour riskier banks offering higher rates for savers. Even without explicit guarantees, no government would let millions lose their savings, which is true. If there is a King blueprint we have yet to see it. (David Smith, The Sunday Times)


1 Comment

  1. I really like when people are expressing their opinion and thought. So I like the way you are writing

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