The economy
A t last, the Chancellor has bowed to the inevitable and removed the
rose-tinted spectacles through which he had previously insisted on viewing
Britain’s increasingly bleak economic prospects. Yesterday was the day when
Alistair Darling was finally forced to confront the grave reality of the
rapidly deteriorating outlook and concede what most of the country has long
known – that Britain is facing the most painful economic slump since the
sharp recession of the early Nineties.
In his drastically revised economic forecasts, the Chancellor abandoned any
pretence that Britain might escape this fate.
Having flown in the face of the facts and insisted as recently as March that
gross domestic product would grow by up to 2¼ per cent this year, Mr Darling
admitted yesterday that – in stark contrast – the economy is now likely to
shrink by between 0.75 per cent and 1.25 per cent next year. That would mark
Britain’s worst performance since the depths of the last recession in 1991,
when the economy’s overall output and income contracted by 1.4 per cent.
Mr Darling’s new prediction is for the new recession to be only a little
shorter than the Nineties episode – lasting for four grim quarters from the
middle of this year, until the middle of next, compared with the
five-quarter slump last time.
He also expects the new recession to be a little less severe than the searing
experience of the early Nineties.
Will his be right? Unfortunately, the harsh truth is that while the Chancellor
was in touch with reality as he drew up yesterday’s forecast, he seems –
perhaps understandably – to have been rather more optimistic when pondering
Britain’s chances for economic recovery.
While, at least on his worst-case scenario of a 1.25 per cent contraction in
GDP next year, Mr Darling is broadly in line with other credible
forecasters, including the Bank of England, he, like the Bank, is pinning
his hopes on a very rapid revival from recession.
The Chancellor is betting that the combination of the “fiscal stimulus” from
yesterday’s tax giveaways plus the Bank’s drastic cuts in interest rates to
the lowest levels for half a century will jump-start the economy and ignite
a resurgence in growth starting in the second half of next year.
In 2010 he now predicts that Britain will return to modest but respectable
growth, with the economy expanding by 1.5 to 2 per cent. In the City, the
average forecast is for growth of only 1.2 per cent next year, with many
economists expecting a much worse outcome.
The clear danger for Mr Darling is that his hopes for such a swift rebound out
of recession might be dashed, and that having stretched the Government’s
finances to breaking point yesterday as he strove to shore up economic
activity, he is left with no financial firepower with which to deal with a
still deeper downturn.
This threat is aggravated by the problem that, for now, interest-rate cuts are
much less effective in rekindling growth than usual, with banks still
hoarding cash and reluctant to lend, and fearful consumers and businesses
reluctant to borrow.
The Chancellor hopes to make up for this difficulty with yesterday’s tax and
spending giveaway. Yet the clear, and very real, risk is that, even with
that enticement, fretting consumers will remain deeply reluctant to spend.
As things stand, Mr Darling’s forecasts already factor in a severe
consumer-led downturn, pointing to Britain quickly abandoning the past,
high-spending habits that made shopping the national pastime. Overall
consumer spending, which has been the economy’s main engine of growth for
more than decade, is now expected by the Treasury to drop next year by up to
1.5 per cent, before bouncing back in 2010.
Few parts of the economy look set to escape the pain of recession based on the
Chancellor’s projections, meanwhile. Business investment is also expected to
wilt, fuelling a slump in overall investment spending across the economy by
as much as 8.25 per cent next year.
The battered manufacturing industries are now forecast to shrink by 3 per
cent, or more, next year. And even after a fall of almost a fifth in the
overall value of the pound over the past 12 months, boosting the
competitiveness of British goods abroad, exports are expected to barely
increase at all during 2009, with overseas markets undercut by a global
recession.
Lurking behind all of this, too, lies the still more menacing spectre of
deflation. The Treasury’s forecasts point to the annual inflation rate
averaging just 0.5 per cent next year.
Darling risks black day as he gambles all on a plunge into the red
The public finances
This was a recession Budget that saw Alistair Darling going for broke –
in more ways than one. Defying his image as a politician of exceptional
caution, the Chancellor took the most extraordinary gamble with the economic
fortunes of the nation, and the political fate of the Government.
Setting the stage for his announcements, Mr Darling told us that exceptional
times called for exceptional measures. He lived up to that rallying cry,
betting on allowing the Treasury’s finances to plunge deep into the red
while seeking to jolt the economy back into life with a “fiscal stimulus” of
near-term tax cuts. By staking the future of the economy on permitting
government borrowing to soar on a virtually unprecedented scale, the
Chancellor truly has “put it all on red” – in this case the
red ink that now stains the Treasury’s accounts.
But the problem with this gamble is that the huge stakes indicated by the
startling size of yesterday’s borrowing figures seem not to be matched by
the potential return in the form of the potential boost to the economy from
his tax giveaway, which emerged as relatively modest in its scale.
Yesterday’s stimulus measures, from the cut in the rate of VAT and all the
rest, add up to about £9 billion this year, and £16 billion next –
or just a little over 1 per cent of GDP in the coming year. This sounds like
a lot. Yet just to stand still, Mr Darling had to spend at least £11 billion
in 2009. This is the amount needed to reapply the political sticking plaster
of £3.9 billion in temporary tax concessions forced on him in October and
which were otherwise due to expire, and to offset previously planned
reductions in borrowing pencilled in for next year. Overall, then, the extra
boost offered to the economy from yesterday’s moves amounts to a relatively
paltry £5 billion.
Contrast this with the startling overall scale of the total borrowing that
the Chancellor now plans, and with the expected rise in the national debt
that will burden present and future generations.
In the present financial year, 2008-09 alone, Mr Darling now intends to
borrow £35 billion extra, almost doubling the Government’s forecast deficit
to £78 billion. Then in 2009-10 borrowing spirals still higher, climbing to
an historic peak of £118 billion, or 8 per cent of GDP, that exceeds even
the 7.7 per cent high reached in the wake of the last recession in 1993-94.
Over five years from 2008 to 2013, borrowing is scheduled to be a disturbing
£231 billion more than previously intended, taking the total for this period
to £394 billion.
The unsurprising consequence is a matching surge in the national debt, which
is now slated to breach the watershed of £1 trillion early in the next
decade, climbing to £1.08 trillion by 2013-14.
Behind this extreme worsening in the nation’s finances lies the toll on tax
revenues from the recession. As the economy shrinks, receipts from income
tax are set to drop by 3.5 per cent next year; those from corporation tax
are set to tumble by 7 per cent. The sheer scale of this deterioration in
the Treasury’s books points to two enormous risks that the Chancellor now
runs.
The first is that his attempt to jump-start the economy fails. There is a
clear threat that the £12.5 billion cut in VAT is not enough to lure wary
consumers to carry on spending. Even if it does, this will only limit the
scale of a recession that could be much worse than yesterday’s forecasts.
Yet the vast amounts that the Chancellor now intends to borrow leave no
scope for further stimulus.
The second, big risk is that these massive borrowing totals trigger a scare
in the financial markets that only worsens the economy’s plight.
Before yesterday economists cautioned that it was vital that Mr Darling map
out a credible strategy to restore the public finances to a sustainable
state through future spending curbs and tax increases.
We saw a little of that yesterday – but only a little. For all the
trumpeting of the Government’s decision to raise the tax rate for the most
well-off to 45 per cent, this move is set to bring in only a helpful but
modest £1.6 billion a year. Markets are also likely to find it unconvincing
that out of £4.8 billion of belt-tightening that Mr Darling intends in
2010-11, and a further £7.5 billion in 2011-12, in each year some £5 billion
is intended to come from extra efficiency savings in the public sector. Past
Treasury attempts to rely on cost-cutting of this kind have seen such
savings prove elusive. The Treasury is also likely to find it politically
and economically testing to stick to an eyewatering squeeze on public
spending growth now pencilled in for after the next election.
The inescapable conclusion is that after yesterday’s tax giveaway a much
larger “takeaway” of tax rises looms in the postelection future.
Unavoidably, those tax rises will also mean that the recovery from recession
will be markedly weaker than it would otherwise be, imposing a heavy
long-term price.
In the meantime, Mr Darling can only pray that his big gamble yesterday pays
off. If it turns sour, then the moment that the Chancellor put it all on red
will end up being a truly black day for the Government.
