Monday, September 14, 2009

Scare Tactics

Babies and pensioners will be left to die in the gutter

Not everyone on the left has been quite as dismissive of the TPA/IOD Cuts Report as Mssrs Maguire and Straw. Pol likes it:

"This useful report is a necessary reminder that few cuts are painless, most affect everyone, though the poor are hit hardest. Get out a political calculator and tot up how many tens of millions of voters will suddenly think that paying down debt fast is not the only priority after all."

In other words, the TPA/IOD have done her spendaholic "government" a real electoral favour. They have blundered straight into the "elephant trap" (her words) that awaits anyone prepared to be specific about spending cuts - cuts scare and repel voters.

Except, as she undoubtedly realises and the poll in yesterday's Sunday Times underlines, the mood among voters has changed drastically. Voters are not quite as dumb as Big Government types like to imagine, and more and more of us have grasped our real choice: spending cuts or even higher taxes.

And according to the Times poll, we voters now favour cuts over higher taxes by a massive majority of three-to-one. Faced with the truly scary prospect of yet more tax, we're looking for an axeman, albeit a smiling humane one.

Which is why the left are now pumping up the other scare: the prospect of "slash and burn spending cuts" poleaxing the recovery before it even starts. As the head of the TUC put it yesterday (number one headline on BBC R4 news):
"Public spending cuts would provoke a double-quick, double-dip recession. Unemployment could exceed 4 million and it would take many years before there was any chance of returning to anything like full employment."
Cut spending and you'll bring on the highest unemployment since the 30s. Is that what you want?

Pol and Mr Kaletsky are promoting the same scare, even if they do concede the need for some fiscal squeeze at some point far off in the indefinite future. Mr K says:

"To tighten fiscal policy immediately beyond the measures already announced in the last Budget could be a big mistake... since the recovery that is now only just starting is unlikely to have developed a self-sustaining momentum by next May or June."

Which may turn out to be true. But according to a useful piece by S Times commentator David Smith, "we should not worry unduly that putting the brakes on public spending will kill recovery". As a new research report from Goldman Sachs reminds us:
"It is worth looking at what happened to the economy the last time the UK tightened fiscal policy aggressively, during the mid-1990s. It performed well. Coming out of deep recession, and aided by a small acceleration in eurozone activity and a big decline in the currency, investment and exports bounced strongly. Aggregate demand grew by 3.5% a year."

Moreover, against that possibility of weakening the recovery, we have to weigh a very real, uncomfortable and scaryscary truth: we cannot afford to carry on as we are.

Remember this: both this year and next, the UK government will be borrowing more (as a percentage of GDP) than any other government among the OECD's 30 member states. When it comes to government borrowing, the OECD's basket case is not Ireland or Iceland or Italy or Greece, but us.

As a reminder, here's how the OECD forecasts our 2010 position relative to the rest of the G7:

True, on the most widely touted measure of government debt outstanding, the OECD reckons we will still be below the average at the end of 2010 - around 90% of GDP vs an international average of 100%. But that measure excludes all the off-balance sheet items we've blogged so often, including £1 trillion + of unfunded public sector pensions, and all the PFI debt. Taking those into account pushes our debt total up closer to 200%.

And we need to remember too that the bulk - yes, the bulk - of our government borrowing today is what's known in the trade as "structural deficit". That's the element of our overall fiscal deficit that will not conveniently disappear as the recession ends. In other words, it is the measure of how much the government is spending beyond its means, even after allowing for the (hopefully) temporary impact of the recession on tax revenues and welfare payments.

According to the OECD, next year our overall fiscal deficit will be 14% of GDP, the highest ever in peacetime. And of that 14%, no less than 10.4% comprises our structural deficit - the deficit which, in the absence of major policy changes, we'll be stuck with even after the economy recovers.

Indeed, as we can see from the following chart, we have been running a structural deficit ever since 2001: So to summarise, the government's current fiscal policies imply that we will continue to run a deficit of around 10% of GDP even after recover from the recession. Which in cash terms is around £150bn pa.

£150bn pa. That is the measure of how far Pol's government is spending beyond its means. It is simply not a sustainable position.

Now OK, even setting aside the scare-mongering rants from the left, there is an opposing view on how pressing the problem is. According to Martin Wolf, the FT's widely respected commentator:

"Even heavy public sector debts are sustainable. The real interest rate paid by the US government on its debt, for example, is below 2 per cent. So servicing a ratio of net public debt to GDP as high as 100 per cent would cost 2 per cent of GDP. It is ludicrous to argue that this would be an insupportable burden. Moreover, for an economy growing at 4 per cent a year in nominal terms (surely the minimum one would expect of the US, in the long term), net public debt could be stabilised at 100 per cent of GDP with a fiscal deficit of 4 per cent of GDP."

A perfectly reasonable view, but it's hard to see how it applies to the UK. For one thing, as we've just said, our deficit is not 4%, but 14%. And even when you strip out the temporary effect of the recession, it's still 10.4%. Moreover, the OECD reckons our debt servicing burden is set to increase rapidly (to nearly 3% of GDP just by next year).

Moreover, the Wolf view assumes the bond and currency markets will be happy to go on funding our deficit at something close to current interest rates. In reality, as we've blogged before, the markets are expecting Cam's government to get a grip. If he flunks it, watch this space - the government's cost of funding will shoot up.

The blunt truth is that Labour have once again racked up spending far beyond the government's sustainable fiscal capacity.

Early cuts are unavoidable. The only question is whether Cam gets on the front foot and undertakes them in a viable controlled manner, or whether he fails to deliver and ends up being forced into a bloody retreat across years of currency crises and emergency budgets.

Scared yet?

PS The slithery Mandy has just been on BBC R4 Today claiming Tory Cuts will burn babies while Labour "tough choices" won't, black is white, and even that Brown never made that claim about Tory cuts vs Labour investment. When confronted with the actual quote, he didn't bat an eyelid. Is there anyone left in Britain who believes anything he says?

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