Wednesday, June 30, 2010

Babies And Bathwater

It's rather important to recognise the difference

The BBC and the Grun aside, everyone agrees that spending must be cut. Now the question is what spending?

And therein lies a considerable risk. The risk is that because we're all in this together, the cuts will be shared out across spending departments pro rata, pretty well irrespective of merit and irrespective of the consequences.

Today's announcement by Ken Clarke that prison no longer works - and by implication prison spending can be cut - is a dismal case in point.

As regular readers will know, we have long been fans of locking up more criminals. As we pointed out in our very first blog on the Cost of Crime, the Home Office has estimated that 100,000 persistent criminals are responsible for half of all our crime. But of that 100,000, only 80,000 are inside at any one time - the rest are out and about creating mayhem. With 80,000 more prison places (ie doubling the existing number of places), we could keep them all inside permanently and halve our crime rate. And the £3-4bn pa costs of the places would be far less than the £80bn odd estimated cost of crime.

According to Ken, prison doesn't work because it can't cure criminals either of their drug habits or their tendency to commit further crime after release. And he certainly has a point. Nothing we've ever seen says anyone knows how to do that with any degree of confidence.

But the idea that community sentences would be a good alternative is pure wishful thinking. In reality, our £1bn pa Probation Services is staffed by Mr Barrowclough's soppy brothers - they're barely capable of tying their own shoelaces let alone supervising a bunch of villains picking up litter (eg this blog). And frankly, we don't believe anyone could do the job successfully.

Our plan is simple - three strikes and you're out (see this blog). If you've already been sentenced to jail twice, on the third offence you're out permanently. Why? Because the stats show that once someone has been sentenced for crime three times, he's more than 50% likely to reoffend:

So prison is most definitely not something we would cut. The first duty of the state - the thing we really do pay our taxes for - is to protect the honest law-abiding citizen. It is unacceptable that cuts should fall there, while aid for space-race India remains untouched.

Which is not to say we couldn't improve the cost efficiency of the prison service. We agree with Ken that £38 grand pa seems like a lot to pay for a year inside. And when you look at the costs of individual prisons you find a huge range. The most expensive cost three times as much per prisoner as the cheapest, and while differing security levels undoubtedly account for some of that, it does suggest some prisons are much more efficient than others.

Actually, I've just been listening to Ken on R4 Today, and the words "back" and "peddling" spring to mind. So we'll see.

As we all understand, these spending cuts are going to be very difficult. But we do expect the government to exercise proper judgement. Sharing the pain is all very well, but we taxpayers have some clear priorities, and we need to see them reflected in the budget allocations. We do not want to find the bath empty of both bathwater and baby.

Tuesday, June 29, 2010

What Exactly Is The National Debt?

The official definition is easy... and misleading

Question - what exactly is the National Debt?

It sounds like a straightforward question and Tyler's Oxford English Dictionary gives a nice straightforward answer - "money owed by State because of loans made to it".

Good. Very clear.

But just out of interest, how does the OED define a loan to the State? "Money contribution from individuals or public bodies to State expenses that is acknowledged as debt".


So the National Debt comprises contributions to State expenses that are acknowleged as debt. Just as an aardvark comprises an animal acknowledged as an aardvark.

See, when it comes to debt, governments have got this chronic tendency to avoid acknowledging anything as debt if they can possibly acknowledge it as something else instead. Like an aardvark, say.

As regular BOM readers will know, we've blogged the real national debt many times - ie the official government debt plus various aardvark/Enron items like PFI, unfunded public sector pensions, Network Rail, and nuclear decommissioning. These are all items that place on taxpayers a clear contractural commitment to make payments at some future date.

Most recently we estimated this real national debt totalled around £2.25 trillion, over 160% of GDP, and getting on for £100 grand for every household in the land.

That's scary enough, but the bad news is that our real debt is even higher.

That's because of our nationalised banks (highlighted by TomTom in comments on yesterday's post). In case you'd somehow forgotten, we taxpayers own 84% of RBS and 41% of Lloyds. And because that means we are now in a position directly to control what they do (hah), both are now officially categorised as being in the public sector. They have been nationalised, and their liabilities are now ours.

When last sighted (end-2009), those liabilities totalled £2.6 trillion (Lloyds on £1trn and RBS on £1.6trn). That's a stomach lurching 180% of GDP.

Can we really be on the hook for all of that?

Well, there are no formal blanket guarantees, so if the balloon went up, in theory, HMG could still walk away. But in reality, walking away from the liabilities of a bank that was 84% state-owned would nuke HMG's credit standing for decades to come. Ex-Armageddon, walking away is inconceivable. Whatever the small print may say, in reality, we are on the hook.

The only comfort is that these £2.6 trillion of liabilities are backed by £2.6 trillion of assets (actually slightly more, once you take account of the banks' equity capital). So with a very favourable wind, we might not end up losing anything at all.

But the liabilities still have to go on HMG's balance sheet, because these banks are now our responsibility.

And in fairness to the Office for National Statistics they are attempting to do precisely that. In fact, they have been working on it for the last 18 months (see articles here). They long ago included the liabilities of Northern Rock and Bradford and Bingley in the official published figures for government debt (although they continue to publish an alternative debt series excluding them). And they hope soon to include the two big ones.

Why the hold-up? It's because the two banks in question are not keen on having their balance-sheet details paraded around in public, and are arguing commercial confidentiality (to which you might say they should have thought of that before they went bust and came crawling to us for a bail-out).

Anyway, the ONS say they expect the banks' inclusion will increase our official national debt, but "only" by up to £1.5 trillion. That's less than the £2.6 trillion total for the banks' gross liabilities because national debt accounting conventions allow governments to net off holdings of liquid assets, of which Lloyds and RBS have quite a few. Why are governments allowed to net off liquid assets when the banks aren't allowed to do so themselves? Search me - those are just the rules (as devised by government officials).

But on top of these bank liabilities there are some other chunky items we ought to consider.

Like what about state pensions? They're a specific state liability in the sense that most of us have contributed to them through National Insurance - or to put it another way, we've lent money to the government through our working lives against a promise of a state pension in old age. And the coalition's new "triple lock" uprating guarantee makes that promise even more water-tight. So depending on the exact assumptions used, that's another £3-7 trillion of debt to add on.

And what about all those big IT contracts we hear so much about (eg the NHS supercomputer)? Many of them commit us to payments far into the future.

Or what about those big defence procurement contracts (such as tranche 3b of the Eurofighter)? They too contain commitments to substantial future payments.

Or what about all the various financial guaranteees (explicit and implicit) we've given to the UK banks which have not been nationalised? Yes, they're only contingent liabilities, but surely our National Debt stats should not ignore them altogether.

The fact is there is a spectrum of liabilities ranging from sure and certain financial debt such as gilts, through specific contracts for future goods and services such as the supercomputer, to contingent liabilities such as bank guarantees. And what we need more than anything is more information on how that spectrum is made up.

The good news is that post-Gordo it does seem that the ONS are moving towards greater disclosure. They have distinguished the following broad types of debt:

  • Direct liability: a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources - eg gilts
  • Explicit commitment: the government’s responsibility for a future liability based on an existing contractual agreement which does not yet give rise to a present obligation. This is because no exchange has yet taken place, and the obligation, and therefore the liability, normally arises on delivery of the goods or services - eg defence procurement contracts
  • Provision: a liability of uncertain timing or amount, which is recognised in the main accounts since payment is probable and a reasonable estimate of the amount can be made - eg expected losses on the past bank bailouts
  • Contingent liability: an obligation activated by a discrete event that may or may not occur - eg possible losses on future bank bailouts 
  • Implicit liability: a moral or expected obligation on the part of the government that is not mandated by law, but rather based on public expectations, political pressures, or the role of the state as understood by the corresponding societies - eg commitment to pay state pension
They also say:
"ONS has a key role to play in presenting the data necessary for assessment of fiscal burden and risk, and as such needs to understand user requirements beyond the National Accounts boundary. The liabilities in this category which will attract the most attention are; future expenditure under PFI, unfunded pension schemes and government guarantees.

While estimates of these liabilities are disclosed as memorandum items or notes in departmental resource accounts, they are not systematically presented in aggregate (whole of government) form.

ONS should consider its role in presenting a wider range of data on government and public sector liabilities, as is the case in other countries."
So to sum up, here's our updated table of the real national debt including the nationalised banks, but excluding contingent liabilities, all commercial contracts except PFI, and implicit liabilities such as state pensions. In other words, it is a conservative estimate:

So that's just £200 grand per household.

We'd better pray those assets sitting in the vaults of Lloyds and RBS are worth something close to what they claim.

Monday, June 28, 2010

Doomsday II - Growth Vs Debt

George may have defused it

Fed up with the Major's rant about overpaid nancy boys betraying the nation, Tyler sought relief in the doomsday machine. Post-George, is it still ticking?

As regular readers will know, the doomsday machine is set in motion when a government's debt interest bill gets so big that the government has to borrow increasing amounts just to pay it.

It's like having a credit card, where instead of paying off the interest each month, you borrow more to cover it. Then, even if you stop using the card to make further new purchases (ie no more new England shirts) the debt still gets bigger and bigger and bigger, right up to the moment when doomsday dawns (ie when the credit card company calls to repossess your children). That's the doomsday machine.

Now, for governments, the key debt total is less the absolute size of the debt in cash terms, and more its size in relation to GDP. That's because governments have the power to raise money from tax, and GDP is a broad measure of taxable capacity. So as long as debt isn't increasing in terms of that overall taxable capacity - the argument goes - everything is broadly under control (eg see this blog).

So for governments, what matters is whether GDP is growing faster than the rate at which debt interest is adding to their existing debt.

On that basis, how are things looking for HMG?

Over Labour's last 3 years things have been pretty grim. According to the Office for Budget Responsibility (OBR), over the period 2007-08 to 2010-11, GDP growth averaged just 1.3% pa (in money terms - ie including both real growth and inflation). Against that, the average interest rate on our debt averaged 4.0%.

Which means that interest costs were increasing our debt by 2.7% pa faster than GDP growth - the government's debt was being increased faster than the taxable capacity of the economy, and the doomsday machine was up and running*.

Fortunately, the OBR now expects a big turnaround. Over the next 5 years it projects GDP growth will accelerate to 5.2% pa (in money terms), whereas the average interest rate on HMG's debt will only increase marginally to 4.1%. That 1.1% gap means that debt interest will no longer be driving up HMG's overall debt relative to GDP.

In a nick of time, the doomsday machine has been stopped.


Well, phew except for one thing - these are no more than forecasts.

For one thing, they depend on real GDP growth returning to a pretty healthy 2.7% average rate. Sure, that's not as wildly optimistic as Darling's last bonkers forecast, but it's still pretty demanding in the face of a stuttering European recovery.

They also depend on the government's debt interest rate (gilt yields) staying well behaved, increasing only modestly from current levels. That could well happen, but only so long as markets remain unconcerned about inflation - one good sniff of inflationary finance and yields would shoot up.

And history is not altogether encouraging. Over the long haul (back to 1800), gilt yields tend to more or less track the growth rate of nominal GDP. But you don't have to go back very far to find periods where yields have remained above GDP growth for years (as was the case for most of the 80s and 90s).

All of which underlines the need for fiscal caution. George does seem to have stopped the doomsday machine, but one false move and the mechanism could soon trip back into action.

*Footnote. The relationship between GDP growth, gilt yields, and the government debt ratio is discussed further in the OBR's first pre-budget report here.  The Economist also has a couple of good articles on sovereign debt, and they have also updated their indebtedness league table, showing us in the second worst position after Spain (but note it's a 2010 snapshot and does not take account of George's budget):

Friday, June 25, 2010

Game Changers

Still at the crease, and maybe even reshaping the game

The inestimable Ruth Lea described Tuesday's budget as a game changer. And she's right. Assuming Cam and George manage to deliver on their tough spending limits, they really will have changed the economic game from last weekend's grim nil-nil draw against Algeria to this weekend's 5-0 triumph over the Hun.


The thing is, there is a chance that Cam's government could turn out to be a game changer in all kinds of different areas. We've blogged our high hopes for Gove's school reforms many times. Elected sheriffs will be a big step in making the police once more accountable to local communities. An end to mass immigration will give us time to heal the wounds inflicted by Labour's self-serving open-door policy.

But one of the most important game changers could be the one being talked about by that most unlikely of high scorers - Iain Duncan Smith. Because IDS is planning to abolish welfare dependency.

Well, OK, "abolish" is is perhaps a bit strong - that would be like finding "the cure" for cancer. But based on his work at the Centre for Social Justice, IDS is going to mount an all-out assault on the welfare trap.

We're all familiar with the problem - 6 million people of working age are entirely dependent on welfare benefits for their incomes. Which means that each of our 29 million workers has to carry one-fifth of a non-worker (even setting aside the 22m children and pensioners).

And this is much more than simply the financial cost. It's well known that workless households are problem households, trapped in deprivation and under-achievement, and passing on that deprivation to their children. It is monstrous that after 15 years of growth, by 2008 we had the highest proportion of children growing up in workless households of any country in Europe (all charts are taken from the excellent CSJ Report Dynamic Benefits - Towards Welfare that Works):

But the question is what should we do about it?

IDS's recipe is simple - we must do whatever it takes to make work pay.

As things stand - despite all Labour's fine words - for very many welfare recipients work simply doesn't pay. Taking paid employment involves the loss of so much in terms of welfare benefits that they face eye-watering effective marginal tax rates - much higher than those faced by our banking friends down on the Wharf.

The following chart shows the average marginal tax rate (MTR) faced by a married couple with 2 children at increasing levels of earned income. As we can see, a couple earning £40k pa faces a marginal tax rate of 30% - ie for every extra pound they earn, they lose 30 pence in income tax and employees' National Insurance Contribution. But a couple earning just £10k pa is on a marginal tax rate of over 90%, once you take account of the benefits they lose from earning an extra pound of their own (2009 tax and benefit rates):

Now if you were facing a marginal tax rate of 90%+, would you feel incentivised to get off welfare and back to work? Honestly?

IDS is intending to cut these crippling marginal tax rates for the poor, and especially for those who are coming off welfare into work for the first time. Instead of losing 60, 70, or even 90% of every pound they earn, they'll hopefully lose 50% or less. There will be a clear financial advantage in going to work.

Ah you say, that's all fine and large, but where's the money coming from? To cut the marginal tax rates for the poor would cost a fortune. Indeed, IDS himself costed his CSJ proposals at £2.7bn pa initially (although longer-term the cost would disappear or even reverse reflecting the higher level of employment). We just don't have the money.

Which is why the cut in high marginal tax rates has to be part of a package. A package in which the financial rewards from work are boosted, but the rewards from remaining on benefits are cut.

As we've blogged before, one way of finding the money would be to redefine the poverty line. If instead of defining it as 60% of median income, we made it say 50% - where it always used to be -  we estimate we would save £20-30bn pa on the working age welfare bill (ie not affecting pensioners). And as we blogged here, after six decades of unparalled economic growth, nobody can seriously argue that 50% of today's median income is poor in any meaningful sense.

IDS should be bold. Yes, he'll pick up no end of flak from the poverty industry, but if he holds his nerve, he could actually turn out to be the biggest game changer of all.

Not bad for someone who was jeered off the pitch just 7 years ago, looking like he'd never play again.

Thursday, June 24, 2010

Deeper In Debt

Keep this handy - you're still going to need it

For yesterday's TPA budget presentation we updated some of our previous charts on projected government debt interest.

As we know, in the run-up to the emergency budget, Cam quite rightly highlighted the fact that Labour's plans involved debt interest escalating to an eye-watering £70bn pa by 2014-15 - nearly £3 grand per family. Unfortunately, although George's budget has reduced that a bit, in the overall scale of things you'd hardly notice:

By 2015-16, debt interest is still forecast to be running at £68bn pa. Which is hardly surprising, given that even after George's tough budget, government debt still goes on increasing in each and every year of the forecast period.

But at least George's budget secured the all-important confidence of the markets. Gilts strengthened further (ie the interest rate on government debt fell), sterling rallied, and two of the major credit rating agencies immediately indicated that the UK's AAA rating was now safe. Which is a big win because it means that even higher debt servicing costs resulting from higher gilt yields now look less likely.

Unfortunately, we can't rule it out entirely. Even if the UK is now viewed once again as a safe haven for international bond investors, taking a 3-4 year view it's quite likely that interest rates around the world will move higher from their current historically low levels. And we will not be immune. So just as a reminder, here's how HMG's debt interest bill looks under three alternative scenarios with gilt yields 1%, 2%, and 3% above the rates assumed by HMT in the budget:

As we can see, with gilt yields 3% higher than the HMT assumption, debt interest costs are nearly £90bn pa by 2015-16. And that would be more or less equal to the entire education budget this year.

Finally, it's worth noting that, despite George's efforts, within a couple of years the escalating cost of government debt interest will still mean the average family will be paying more in tax to cover it than it's having to pay in interest on its own mortgage:

Wednesday, June 23, 2010

When Is A Cut Not A Cut?

We've been round these loops before

"UK faces worst cuts since World War II says IFS."

Thus the BBC headlines today's invaluable budget analysis from the Institute for Fiscal Studies. Which tells you precisely how the BBC and the rest of the left sees the issue of fiscal restraint. Because when you read what the IFS actually says, they don't use the highly emotive word "worst" at all. What they actually say is:

"We are looking at the longest, deepest sustained period of cuts to public services spending at least since World War II."
Which is pretty well what we blogged yesterday.

According to the IFS, if you add the cuts already announced by Darling to those announced by Osborne yesterday, and if you add in the announced tax increases, you end up with a total fiscal squeeze of getting on for 7% of GDP by 2015-16:

As we can see, 77% of the total 2015-16 squeeze comprises spending cuts, which comes out at getting on for £130bn in cash terms, or around 15% of total public spending (TME).

So the cuts are going to be long and deep, which nobody can deny.

Well, nobody that is, except extremely naive people who simply look at the government's spending projections.  People like John Redwood, who at the TPA's budget briefing today, drew attention to the plain fact that under the Osborne plan, total public spending is not facing any cut at all. In fact, it is projected to increase from £697bn this year to £758bn in 2015-16, a rise of 9%.

Cuh! How naive can you get?

It puts Tyler in mind of a naive Chancellor who told his officials he wanted to manage public spending on a cash basis, just like ordinary people in the real world have to manage their own spending. You can imagine the pitying looks he got from the mandarins, who'd spent their entire careers devising arcane and convoluted procedures to manage public spending in so-called "volume terms". The priority, you see, was to focus policy attention on the volume of provision rather than the second-order issue of its cost (for a flavour of that world, see this dense Treasury brief from 1979).

That Chancellor was Geoffrey Howe, and he went on to transform the system of public expenditure control so that henceforth it focused on simple naive old cash rather than volume projections in RPE adjusted cost terms. It was a vast improvement, particularly in terms of fiscal control.

And when we look at today's spending plans in those simple old naive cash terms we find the following:
  1. Departmental spending on current services (including all those doctors and nurses etc) is planned to be roughly unchanged over the next 5 years
  2. Departmental spending on capital projects is planned to fall by £13bn pa (26%) - the entire cut decreed by Darling
  3. Annually Managed Expenditure (largely welfare) is projected to increase by £74bn (23%)
  4. Total Managed Expenditure is projected to increase by £61bn (9%).
So with the possible exception of capital spending, where are those worst-ever cuts?

The fact is that when people speak of cuts, what they're usually talking about is the cash spending plan deflated by the projected increase in average prices across the economy (GDP deflator). As noted above, total cash spending is projected to increase by 9%. But with average prices forecast to increase by 13%, the inference is that real spending is planned to be cut by 4%, with much bigger cuts for many individual programmes.

But what if the price of the stuff the public sector buys increases by less than 13%? Sure, we know that for most of the last 13 years, the price of public purchases (including labour) has increased much faster than average economy-wide prices, but that's not an immutable law.

If through a mix of pay freezes/cuts and contract renegotiation the price of government purchases could be held down, then suddenly the "cuts" start to disappear. Indeed, if the price increase could be held below 9% over the 5 years, then overall public spending in real terms doesn't get cut at all.

In the real world, families and businesses react to straightened circumstances by seeking out cheaper sources of the goods and services they need. It's time the public sector did the same.

Tuesday, June 22, 2010

Marks Out Of 10?

Most of the work is done by rising tax receipts

We'd give George's Emergency Budget 7½ out of 10.

Naturally we liked the £1000 increase in the personal tax allowance, the promised 4% cut in Corporation Tax rate, the tax cut for small businesses, and the cuts in payroll taxes.

We also liked the faster progress back to fiscal balance, the squeeze on ballooning welfare, the two year public sector pay freeze, and the promised cuts in departmental spending limits.

However, we didn't like the increase in VAT, and we didn't like his various other smaller tax increases.

We also remain concerned by the lack of detail on what exactly gets cut in terms of departmental spending.

All he told us today was that he's intending to cut something like £65bn pa by 2015-16, around 15% in real terms. However, given that the NHS and international development are ringfenced against any cuts, and that education and defence will be protected against the worst cuts, every other department is facing a 25% cut.

Cuts on that scale have never ever been achieved by in peacetime. Clarke achieved 6% in the mid-90s, and even that was hugely assisited by peace dividend cuts in defence. Callaghan managed just 4% following the 1976 sterling crisis, but that only with the IMF supporting him. Even the famous Geddes Axe following WW1 only delivered its 25% cuts in central government spending because local authorities increased theirs.

George says the autumn spending review will fill in the detail. We'll take him at his word.

Let's hope we don't have to downgrade his score when we see the results.

Monday, June 21, 2010

Will George Do Enough?

When it comes to deciding whether individual governments are over-indebted, the financial markets have long had a rule of thumb, one that has been taken up by international organisations like the IMF, the OECD, and the EU. It is that an individual government should not run up debts equal to more than 60% of its country's GDP (the maximum under the original Maastricht rules).

Why 60%? Well, it's not cast in concrete, but history tells us that once governments go above that level, they are in the financial danger zone. Debt interest is burdensome, and there's no more wiggle room. Unforeseen problems like future recessions can leave them highly vulnerable to a collapse in market confidence - struggling to convince investors they should lend more, undermining their bond markets, and plunging their currencies into the abyss.

Right now (2010-11), the UK is on 78%, so already well above the safe limit. And according to last week's forecasts from the Office for Budget Responsibility (OBR), our debt ratio is set to rise to nearly 90% by 2014-15.

Except of course, it's even worse than that. As regular BOM readers will know, once we add in Brown's off-balance sheet Enron debts, like PFI and public sector pensions, HMG's total debts more than double from the officially declared level (a point highlighted by the OBR themselves).

And that is the scale of George's task. He has to chart out a credible path to get our government debts - our real government debts, that is - back below 60% of GDP.


First, and foremost he has to cut spending. And we'll be watching his delivery on that score very closely (including a credible commitment on those expensive public pensions).

Second, he has to get the economy moving. A bonfire of red tape for sure, but critically, he has to cut business and payroll taxes, and not fund those cuts by increasing other taxes.

Third, he has to be radical on public sector reform. What that means more than anything is letting go - a wholesale move to choice and competition and away from state monopoly (see many previous blogs). Only by doing that, can we ever hope to cut waste in the public services and improve productivity.

Tomorrow we'll be following this landmark budget from the TPA's office, and we'll post some reactions on the TPA website.

England expects, George.

Sunday, June 20, 2010

Budget Responsibility

Early bath for the team but no early pension for anyone

Back from France, which despite our close and painstaking investigation, still manages to baffle.

Take the fiscal crisis. Just like us, they are wrestling with a deficit. But whereas ours is 11.5% of GDP, theirs is only 6.9% (latest OECD forecast for 2010). Despite the fact that they're the ones whose government has always spent money like water - government spending is 55% of GDP this year, even higher than ours.

Last week the French TV news reports were full of Sarko's formal announcement that their state pension age is to be increased. But whereas Cam is trying to find some way of telling us ours will soon move to 70, the French are rioting over having to accept an increase to just 62. 62!

Still at least Les Bleus have flopped in South Africa, causing much wailing in les rues and subjecting the French nation to appalling humiliation in the eyes of the entire world. Thank God our guys would never do that to us (how've they been doing, by the way).

So what's been happening here since we've been away?

Plenty of pre-budget spin, obviously, and it sounds like George really is going to go for the full austerity package straight off the bat. Good.

Last week also saw the publication of the Office for Budget Responsibility's first ever Pre-Budget Report. While not yet quite the finished item, it's a vast improvement on anything we've ever been given before.

To start with, the economic assumptions are properly explained, and there is an explicit recognition of the uncertainty surrounding the central projections. The fiscal projections also feature an explicit range of possible outcomes, neatly summarised in a Bank of England style fanchart:

Thus, on the basis of current policy, the OBR forecasts Public Sector Net Borrowing (PSNB) in 2014-15 of 3.9% of GDP, down from 10.5% this year (2010-11).

However, there is a 50% chance it will be higher than that, and around a 25% chance it will be higher than 6%. Which suggest George needs to err on the side of bigger rather than smaller cuts - especially since the OBR also notes that previous budget forecasts going back to 1987 have on average been far too optimistic (quelle surprise).

The OBR also spells out some of the spending detail signally omitted from previous budget publications.

For the first time, they include the controversial numbers for debt interest payments (forecast to increase from £42bn this year to £67bn in 2014-15).

They also break down total spending out to 2014-15 into Departmental Expenditure Limits (DELs) and Annually Managed Expenditure (mainly welfare benefits). Unfortunately they can only give the figures implied by Darling's last overall spending projections since new ones have not yet been set (they've used a very similar residual methodology to that previously employed by the IFS). But the projections are still striking.

In particular, the OBR says that current plans imply a £6bn cash cut in Departmental spending by 2014-15. Adjusting for their inflation forecast (GDP deflator), that implies a real terms cut of over 10%, or around £40bn pa.

And do you know what that means?

It means that to fill his c£80bn fiscal hole, George needs to find the same again from somewhere else.

Which is why welfare is squarely in the firing line.

And why we still feel very nervous about his tax plans.

PS The scariest table in the OBR's report is not concerned with the short-term fiscal outlook at all. It's a summary of the burden we are facing over the next four decades from our ageing population (Mr and Mrs T included). It shows the increased proportion of GDP currently set to be gobbled up by public pensions, healthcare and long-term care. Total age-related spending is set to increase from 22.5% of GDP last year to over 26% by mid-century. Which means pushing up the retirement age to a mere 70 may not be enough:

Thursday, June 10, 2010

French Leave

They smoke, drink, have loads of sex, yet still live forever.
Well, some of them do anyway.

Mr and Mrs T are off to France for a spot of R'n'R.

Always been a bit of a mystery, France. I mean, they smoke more than us, they drink more than us, and according to the Major, they have a load more sex than us. And yet their life expectancy is higher than ours, infant mortality is lower, and far fewer of them are clinically obese (don't take my word for it - here are the official OECD stats).

And more than that,  how does that economy of theirs actually work? Everybody knows they knock off for four hour lunches, spend most of the summer en vacance, and clock up 20% fewer working hours than us. Add in the fact that they have even bigger government than we do, great dollops of covert industrial subsidies and state support, and by rights their economy should be a wreck. Yet when it comes down to it, their per capita income is only a bit lower than ours (8% on the latest count). How can that possibly be?

OK, they've always done a bit better than us from the EU, but surely that can't be the explanation.

It's a complete mystery.

A mystery we will once again attempt to unravel over coming days.

Wednesday, June 09, 2010

Seriously Though...

Now he tells us:
"There is nothing progressive about a government that consistently spends more than it can raise in taxation and certainly nothing progressive that endows generations to come with the liabilities incurred with respect to the current generation...
I found it very frustrating to sit in meetings with some of my fellow ministers talking about creating jobs in the green economy, creating jobs in biotechnology. The Government can't create jobs. The Government can create the environment which is conducive to the creation of jobs but it cannot create jobs and we mislead ourselves if we believe it can."
That's absolutely brilliant My Lord.

Just a shame you didn't think to mention it before.

Of course, ex-Treasury Labour Goat Myners at least got a peerage for his collaboration with Stalin - all the rest of us got was a serious headache and two decades of penury.

But seriously though, just how are we going to dig ourselves out of Labour's latest horribly deep hole - deeper and more horrible than any previous hole even they've managed to fashion?

Ratings agency Fitch advises us to tighten our belts a few notches:
"The scale of the United Kingdom's fiscal challenge is formidable and warrants a strong medium term consolidation strategy...

"Both the size of the deficit currently projected for 2011 and the failure to reduce the deficit to 3 percent of GDP within five years are striking... A more ambitious deficit-reduction path — with borrowing 1 percent lower than in budget 2010 through the medium term — would result in an earlier peak in the debt/GDP ratio and a clearly declining debt path within the medium-term horizon, helping to go some way to restoring fiscal space, or a cushion against further shocks."
Yes, but what does that actually mean? We've been trying to work it out, and to help us we've taken a quick look at George's latest public spending paper.

Let's start with his summary chart on Labour's management of the public finances - total expenditure vs total tax receipts, both as a percentage of GDP:

As we can see, whereas receipts trundled along fairly steadily at an average 38% of GDP, expenditure was on the increase virtually from the start. We moved into deficit in 2001-02, and remained there ever since - despite the economic boom up to 2007.

So starting from the gap we now have, to cut borrowing from this year's 11% of GDP down to 3% by 2014-15 entails some combination of the following (and do stop me if you've heard all this before):
  1. Spending cuts - other things equal, we'd need to reduce spending by about 17%, or £120bn pa - roughly the entire UK NHS budget, say.
  2. Tax increases - other things equal, we'd need to increase tax revenue by around 22% - hiking the standard rate of income tax from 20p to 50p might do it (at least, according to the HMT tax ready reckoner)
  3. Increase GDP - the magic bullet - it not only increases the denominator in our calculation of borrowing as a percentage of GDP, but more importantly it generates extra tax revenue for a given set of tax rates, and reduces welfare spending as more people move into work.
Have a quick ponder on those alternatives.

Spending cuts are definitely on the agenda, and yesterday George published his framework document explaining the process by which he will attempt to deliver them. Including his hopes to engage the public in thinking the unthinkable.

But engagement or not, just how much cutting will the public tolerate over a single Parliament? And more to the point, just how many by-election defeats will Cam/Clegg tolerate? The TPA/IOD have proposed cuts totalling £50bn pa (see this blog), but even those - many of which have been rejected by Cam/Clegg - fall way short of Fitch's implied £120bn target. However much we might want to see cuts of that magnitude, realistically it just ain't going to happen.

Tax hikes are already coming thick and fast, including the new 50p top rate, higher employees' NICs, and the prospective VAT increase. But a hike delivering £120bn pa isn't on anyone's hitlist.

Besides, the one thing we must all understand by now is that tax hikes would zap any chance of help from our third alternative - the one real hope of escape - GDP growth.

As we've blogged before, the old HM Treasury rule of thumb says that a 1% increase in GDP (relative to trend) cuts the fiscal deficit by around 0.7% of GDP, through its impact on tax receipts and welfare spending.

Which in our current predicament is really rather encouraging. Because it means that we could achieve Fitch's target without spending cuts and without tax increases if we could just somehow grow our GDP by around 11% from current levels.


Surely that can't be too much to ask, can it?

Why, our last Chancellor but one wouldn't have wiped his spotty behind on a mere 11%. Over 5 years that's just 2% pa - a tad below our actual long-term trend growth rate, let alone his own historic achievements.

And that is why George really must do whatever it takes to promote growth. Not the kind of growth that depends on government support and subsidy - the green economy and biotech nonsense Lord Myners is now so irritated about. No, we must have the kind of self-sustaining growth that takes place in the real world of the market economy. And that means cutting business and payroll taxes soonest, and all other growth destroying taxes immediately thereafter.

Of course, a market-based growth strategy is no substitute for spending cuts. They need to happen anyway, and George will need to accept and spell out a decade of severe restraint. Sharing the proceeds is dead for the forseeable future, and instead, public spending growth will be held well below the growth of the economy.

But a strategy based on promoting growth offers us hope. And as we enter our decade of cuts, cuts, cuts, and more cuts, hope is something that will be in pretty short supply.

Tuesday, June 08, 2010

"**** My Victims"

You're going down Bliar

"**** my victims. I carried them for 20 years, and now I'm doing 150 years."
What a brilliant Cagneyesque line. Never mind that he broke the law, Bernie Madoff fingers his greedy victims as the real culprits. He tells a fellow prison inmate:
"People just kept throwing money at me. Some guy wanted to invest, and if I said no, the guy said, 'What, I'm not good enough?' "
You've got to love him. Here's a man who lied and cheated and ran the biggest Ponzi scheme America has ever seen. When the scam finally imploded, his punters were ruined. Yet it turns out he was the real victim himself.

It's like say... oooh... I dunno... suppose some bunch of snake oil politicos promised a bright new dawn of plenty for all, got elected by a gullible public, spent borrowed money like there was no tomorrow, got elected again, spent even more, and carried on like that for years. Obviously when the scam finally imploded, the public would turn on them, sling them out of office and into jail.

Those politicos would probably feel like victims too. After all, if the stupid voters hadn't fallen for the fantasy hook line and sinker, they would never have insisted on such fraudsters staying in power for so long.

Of course, in the real world that could never happen. Failed fraudster politicos don't go to jail. They go to the House of Lords.

PS So just why are busted disgraced Labour getting so much uncritical airtime? Ex-gay marriage and keeping us out of the Euro, every other single thing they touched has turned into a major disaster we now have to somehow sort out. And yet the humbugs currently standing for the Labour leadership - people like the arch-hypocrite Abbott - are treated as if they're perfectly reasonable and respectable members of the community. As for their attempted volte-face on mass immigration, and their stated belief that it's perfectly OK to assassinate Tory leaders... don't get me started.

Monday, June 07, 2010

Wanted - 4m New Jobs

We need 4m of these

Judging by the rhetoric, it really does seem Cam gets it. Public spending needs drastic surgery and Cam sounds like he's ready to wield the knife. Thank goodness.

The question being asked now is where will all the post-cuts jobs come from?

To recap (see this blog), Labour increased public sector employment by around 1 million. Which means that the official public sector payroll is now just over 6m (including 200,000 in our nationalised banks). To that, you need to add those who are effectively employed by the public sector but for arcane historical reasons are not counted on the official payroll (eg GPs and university lecturers). You also need to add in a bunch of subcontractors (including those notorious consultants) who are doing jobs that were traditionally done by public sector staff themselves. We reckon that takes the overall total to at least 7 million, or about one-quarter of all those currently in employment.

The cuts mean that number has to fall. How much? Cuts of 20% in overall Departmental Expenditure Limits have been widely touted, which on a base of 7 million could translate into 1.5 million jobs.

1.5 million new jobs would be bad enough, but of course, the much discussed jobs shortage could be even worse than that.

As we all know by now, in addition to the 7 million employed by the government, there are a further 6 million people of working age living on benefits. They too are a burden taxpayers can no longer afford, and Cam has instructed IDS to get them back to work.

How many of them will be looking for jobs?

Well, 1.5m of them are on Job Seekers Allowance (JSA), so in principle all of them need jobs. In reality of course, there will always be a certain level of short-term frictional unemployment, so let's call it 1m new jobs needed.

A further 2.6m are on Incapacity Benefit and Employment Support Allowance (ESA). Everybody understands many of these people are fit for work and simply disguised unemployed, and while we don't know precisely how many, the general estimate is 1m. So that's another 1m jobs needed.

Then there are 0.7m lone parents supported by benefits. Again, the expectation is that most of them ought to be put back to work - call it 0.5m.

So totting it all up, to employ all these people coming off the public payroll and welfare, we will somehow have to discover around 4m new jobs. All of them in the private sector.

Can it be done?

Well, the good news is that last time we faced a similar problem back in the 70s, the economy did subsequently manage to generate millions of new jobs. In fact, over the subsequent thirty years, nearly 6 million net additional jobs were created. And that was despite an eye-watering 4 million slump in manufacturing jobs.

Where did the new jobs come from?

Admittedly, 2m came in health, education, and public administration, largely taxpayer funded. But even more important, jobs in finance increased by a whopping 4 million. And they weren't funded by taxpayers.

Here's the complete picture (click on image to enlarge, and see this blog for more details):

Now, I know what you're thinking - we can't depend on high risk finance for our future jobs. And you know, you may be right (although personally, Tyler reckons finance will surprise us - it has always been an industry in which we excel, and the global opportunities remain vast).

So finance aside, where will the jobs come?

Answer: we have absolutely no idea.

And neither does anyone else.

The truth is that back in the 70s few would have forecast the pattern of jobs growth over the next 30 years, and it's no different today. Seers such as Will Hutton's Work Foundation may reckon they can chart the path ahead, but here on BOM we're much less confident (and see here for a good demolition job on the Work Foundation's past record - HTP Ben W).

But what we are much more confident about is that given a chance, the market will deliver. And the six key steps Cam must take to give it that chance are as follows:
  1. Cut taxes - especially business and payroll taxes
  2. Slash red tape - including restrictions on working practices
  3. Abolish the minimum wage - alongside a programme of welfare cuts, we need to junk the minimum wage - low productivity workers in high unemployment towns like Dewsbury simply cannot find jobs at those rates (see this blog)
  4. Break up public sector monoplies - especially in the world's boom industries of healthcare and education - private sector providers would soon build expertise and sell it around the world
  5. Decentralise - including giving our old bombed out industrial cities charter status (eg see this blog) - remembering that the bulk of these new jobs will be required in precisely those areas
  6. Cap immigration - yes, we know we all benefit from some high skill migrants, but as we've blogged many times, net net Labour's open door policy hasn't made us richer, whereas from Slough to Lincolnshire, it has taken low-skill jobs from low-skill unemployed locals.
None of it is easy. But as Mr Cam told us this morning, nothing is going to be easy.

Sunday, June 06, 2010

Red Books

Not in great shape

What's black and white, and red all over?

Yes that's right - it's the books.

And now Cam has finally seen them, he's shocked. It turns out Brown/Darling made some preposterously optimistic assumptions on growth and debt interest:

“There were two levels of optimism in what the [Labour] government was forecasting. One was trampoline growth of 3% and above, and the second theory was that interest rates would always stay low.
One of the most shocking things is the extent of the interest we are paying on our debt. If we don’t do anything about it, it is going to be £50, £60, £70 billion.
It is going to be huge. We will be spending more on debt interest than we do on educating our children and defending our country. It is totally irresponsible what we are left with.”
Who would have thunk the books would show that?

It would of course be churlish to point out that both of these "shocks" have been blogged to death on BOM for the last several years (eg see here). The main thing is that Cam is now fully seized*.

And now that he's on the case, he identifies some other old BOM favourites for cuts:
“You have to address the massive welfare bills. You have to address public sector pay bills. You have to address the size of the bureaucracy that has built up over the past decade.
Otherwise you will have to make reductions across the board which you don’t want to do. We need to address the areas where we have been living beyond our means.”
As we've blogged many times, the public sector paybill and the welfare bill together comprise nearly 60% of total public spending - they have to be cut. And while Cam has already announced a partial public sector pay freeze for next year, it now sounds like he's going to extend it into the years beyond (as recommended by the TPA/IOD cuts paper here). Good.

So will George's budget avoid further tax rises?

Unfortunately, Cam still refuses to rule out a VAT rise, which now seems a virtual certainty. However, he is back peddling on the prospective CGT rise. Claiming he "did not come into politics to punish people who want to do the right thing and save”, he suggested  there would be relief for those who hold assets for a long period (something like Brown's short-lived taper relief).

But whatever the specific decisions on tax and spend, there is one thing Cam and George absolutely must do - they must make absolutely certain the budget delivers the full package. Maybe not the final detail on what individual programmes each department will cut - that will come in the autumn spending review - but everything else must be there (including the so-called "spending envelope" for Departmental Expenditure Limits).

*Footnote Yes, we know - as Mrs T keeps saying, it's all very easy for Tyler to sit at his keyboard in his pyjamas tapping out tales of fiscal doom, but Cam has to take the country with him. Blaming the books may be the oldest formula in the, er, book, but like all fairy tales, it resonates with something deep in our collective soul. You can't really blame Cam for using it. Especially when he already looks terminally knackered.

PS BOM banned in Beijing. One of the junior Tylers has just returned form China, and reports that BOM is banned there. Which is very encouraging. Especially since Guido is not banned. (We've blogged China several times, and presumably we're banned for posts like this).

Friday, June 04, 2010

Locked Into Welfare Dependency

In this New Age of Austerity it has always been baffling why our £7.3bn pa overseas aid budget should be ringfenced and protected from cuts.

Yes, of course, we all understand the Nasty Party's political desire to rebrand itself - although we should note they haven't offered the same blanket guarantee for welfare here at home, where cuts will be seen to be a whole lot nastier than cutting aid to some faraway country with people about whom we know nothing.

But these are tough times, and political decontamination aside, the key point about overseas aid is that there is absolutely no serious evidence it actually works.

Specifically, economic aid - which comprises the vast bulk of that £7.3bn - has had no discernable effect on economic growth rates in recipient countries. When the IMF conducted its own comprehensive statistical study of all the evidence since 1960 it concluded:

"We find little evidence of a robust positive impact of aid on growth... To be more concrete, in the cross-sectional analysis, we find some evidence for a negative relationship in the long run (40 year horizon)... We find some evidence of a positive relationship for the period 1980-2000, but only when outliers are included. We find virtually no evidence that aid works better in better policy or institutional or geographical environments, or that certain kinds of aid work better than others."
A pretty damning assessment - no convincing evidence it works overall, and no evidence that tweaking the details makes any difference.

So why has aid failed?

The theories are many but they largely boil down to the fact that aid has propped up dysfunctional and corrupt regimes in recipient countries, and has grossly distorted incentives across the wider economy. As this excellent overview by Zambian aid guru Dambisa Moyo puts it (and you really should read the whole piece):

"Over the past 60 years at least $1 trillion of development-related aid has been transferred from rich countries to Africa. Yet real per-capita income today is lower than it was in the 1970s, and more than 50% of the population -- over 350 million people -- live on less than a dollar a day, a figure that has nearly doubled in two decades...
...A constant stream of "free" money is a perfect way to keep an inefficient or simply bad government in power. As aid flows in, there is nothing more for the government to do -- it doesn't need to raise taxes, and as long as it pays the army, it doesn't have to take account of its disgruntled citizens. No matter that its citizens are disenfranchised (as with no taxation there can be no representation). All the government really needs to do is to court and cater to its foreign donors to stay in power...
Then there is the issue of "Dutch disease," a term that describes how large inflows of money can kill off a country's export sector, by driving up home prices and thus making their goods too expensive for export. Aid has the same effect. Large dollar-denominated aid windfalls that envelop fragile developing economies cause the domestic currency to strengthen against foreign currencies. This is catastrophic for jobs in the poor country where people's livelihoods depend on being relatively competitive in the global market."
Now that is enough to make anyone grind their teeth - western taxpayers shelling out billions to inflict rotten governments and uncompetitiveness on the world's poorest people - consigning them to perpetual welfare dependency and dirt poverty (we have blogged this many times - see previous posts gathered here).

So why haven't we just stopped? Why haven't we slashed our aid spending back to what most of us always thought it was in the first place - ie disaster and humanitarian relief (which would mean cutting roughly 80% of our aid spending).

The answer is twofold.

First, western politicos do not wish to be seen as nasty - they much prefer to be photo-opped on stage with Saints Bob and Bonio, bathed in golden light.

Second, the global aid industry has now grown very powerful and can make life extremely uncomfortable for those who seek to cut its food supply. The big consultancies and NGOs making up this industry have large and sophisticated lobbying and propanda arms (largely funded by the very taxpayers they are fleecing). Even the mighty IMF had to bow before them, issuing a post-publication disclaimer of that damning research report quoted above:
"This Working Paper should not be reported as representing the views of the IMF."
Now, in fairness to Mr Cam and his team, they do at least seem to understand there's a problem. Back in January we blogged their sensible decision to fold the DfID budget in with that of the MOD and the Foreign Office, so that we can at least start to use the cash to support our strategic national objectives. And now Andrew Mitchell says he'll try to demonstrate we taxpayers are getting value for money:
"We will never maintain public support among hard pressed taxpayers for this vital and large programme unless we can demonstrate independently that when we spend £1 on development we are actually getting 100 pence of value.

We need to move the whole approach of aid and development towards looking at the results, what we are actually achieving on the ground, and away from an approach which is too dominated by impact and putting money on the table."
Which sounds like a much better approach than what we've seen previously. Moreover, he's already stopped the lunacy of aid to Russia and China - China FFS! - although he's not yet done anything about the equally ludicrous flow of aid to booming space programme India (see this blog).

But as we've said many times, words are one thing, action something else. We will need to follow Mitchell's progress very carefully.

PS Talking of locked into welfare dependency, the TPA's Research Director Matt Sinclair was on BBC R4's Moral Maze this week talking about the need to reform welfare benefits here at home. Well worth hearing, and you can do so here.

Wednesday, June 02, 2010

Feet Of Clay

The Pru's soon-to-be-ex-CEO in conference with St Bob

Here on BOM, we write a lot about mendacious self-serving politicos and overpaid incompetent public sector managers. They're our stock in trade - the dreadful people who consume half our national income.

Cynical? Well, we long ago learned that even the brightest and the best of these people have feet of clay. When by some chance we've enthused about one of them, more often than not, that person promptly lets us down (eg see our many posts on boonie king Sir John Bourn, the now disgraced ex-head of the National Audit Office).

The depressing case of David Laws is a prime example. Here was a man we praised at the start of last week - praised for his clear grip on the most difficult problem we face, and his apparent willingness to take the political heat in order to promote the national interest. A man to admire.

The next thing - blow me down - it turns out our shining new hero has been up to his grubby haunches guzzling in the trough. Sure, he may have been shopped by dark homophobic forces working to undermine the coalition, but that's no excuse - he's the one that did the guzzling.

Worse, it seems his emergency replacement - who let's face it, is only just out of secondary school and obviously knows next to nothing about matters fiscal - may have already been involved in second home flipping and rinsing his travel perks.

Feet of clay. But still daring to stand in authority over the rest of us.

Yes, we can all see that.

But what to do?

Our prescription is simple - break up the public sector, privatise where possible, localise where necessary.

Simple, yes, but surely there are just as many egregious plonkers running private companies. Why should anyone believe they'd be any better than the lot running the public sector?

Yup, there's definitely some truth in that. And as it happens, we've just witnessed a Grade A case in point.

You will have seen that the Prudential's hugely overpriced $35bn bid for AIG's Asian business has collapsed in ignominy and bitter recrimination. The Pru's Chairman Harvey McGrath, and Chief Exec Tidjane Thiam, are widely seen to have brought this fine old British company to the point of catastrophe through their Fred the Shred style mix of arrogance and incompetence.

They may have talked a great story of sunlit uplands and plenty for all, but when it came down to it, they were apparently quite prepared to sacrifice the financial interests of their shareholders to further their own vaulting and vainglorious ambitions.

Unsurprisingly the shareholders are furious - especially since they now understand the CEO was actually trying to dump them:

"Thiam faces a bigger charge: forgetting that although the money and deal was Asian, crucially it depended on a vote by British investors. Thiam's proposal was to create a vast new Asian-focused insurer where the shares and the value of the company would be in Asia, at the cost of the existing shareholders.
As one expert observer said: "Tidjane wanted to fire his current investors and get some new ones. He just forgot about the vote."
Now, we know some other people who'd like to fire their traditional supporters and get some new ones, don't we. It's no surprise that the ambitious Thiam has already had one spell as a politico, and that according to one rumour, as a French citizen, he has set his ultimate sights on the Presidency of La Belle France itself.

It's all so very very like the behaviour of our own dear politicos.

And yet there are some key differences.

First, these jokers have been stopped by their voters (aka the shareholders). Under the Pru's constitution they could not proceed with the lunacy without holding a referendum to get shareholder support. And there has been a shareholder rebellion the like of which the City has not seen in many a year*. If only we voters had such a lock on our Westminster politicos.

Second, there will be consequences both for the management of Prudential and probably the company itself. Private sector companies that screw up like this tend to get eaten by rivals who haven't. Choice and competition mean that evolutionary rules apply. Unlike one-size-fits-all Big Government, private sector companies cannot make huge and wasteful mistakes with impunity. Nature ensures change and improvement.

So yes, feet of clay exist all over.

But only in government do we carry on pretty well along the same old road irrespective of whose feet are on the control pedals. We desperately need to break it up.

*Footnote - As others have pointed out, the Pru shareholder rebellion could be a turning point in UK corporate governance. For the first time in living memory, institutional shareholders have flexed their muscles and said no to a high-rolling high risk management team. That's precisely what the textbooks say they should do, and precisely what they didn't do during the great financial bubble. Maybe there is hope for the future after all.