Apocalypse Now: A return to high borrowing, high taxes and weak growth

April 22, 2009


Gerard Lyons is chief economist at Standard Chartered. Any opinions expressed are his own. –

Britain is clearly a Jekyll and Hyde economy. Or that at least is what the Chancellor would like us to believe. The bad news we are now seeing in the economy, public finances and across parts of the financial sector will not last. We are in the Mr Hyde phase. But, don’t worry, we will soon be back to the normal Dr Jekyll soon.

The Chancellor believes the recession will end by year end. That is credible. But then he believes recovery will be rapid, and after contracting 3.5 percent in 2009 we will see growth of 1.25 percent in 2010 and 3.5 percent in 2011. This is fantasy, particularly as this rapid rebound is expected to occur not only as the legacy of the debt bust lingers on, but also as fiscal policy is tightened aggressively through significant tax hikes, largely on those on high incomes.

Strong growth, tax increases and efficiency savings are, the Chancellor believes, about to reduce the budget deficit by half over the next four years. I have my doubts. The legacy of this borrowing binge will live on for much longer.

What we saw confirmed today was the UK was returning to high borrowing, high debt and – in our view – much weaker growth than the Government believes. Add in the higher regulation that is likely to hit, and one wonders how the UK will prosper as the shift in the new world economic order, which is already underway, gathers momentum. As we see a further shift in the balance of economic and financial power from the West to the East, to those economies with low taxes and which save and invest, how will the UK be able to prosper?

There were three areas to focus on in the Chancellor’s Budget speech:

The first thing to note was how the Chancellor tried to prepare us for the bad news he was about to deliver. It is not our fault he said. The Chancellor had a number of defences: he had already taken measures to help, the downturn was global, all forecasts had been reduced not just his, and as bad as this recession is, he outlined a relatively quick rebound to strong growth, which in turn would allow government borrowing to fall. Robert Louis Stephenson would have been proud.

One could not argue with the Chancellor’s opening paragraphs when he highlighted the shocks that have hit in recent years, and the global nature of the financial and economic crisis. Moreover, he used this as justification for the measures already unveiled, claiming credit for the boost he provided in the Pre-Budget Report at the end of last year. He claimed the total support provided would safeguard half a million jobs. And he announced further measures to help employment today.

These measures are to be welcomed, it is vital to keep youth unemployment to a minimum. But even with this, unemployment will rise sharply, and for some time. Although the Chancellor made the best of a bad job in delivering his Budget nothing could hide the poor underlying foundations on which he built his story. The Chancellor believed the economy’s underlying strength, in terms of its diversity, flexibility and resilience would allow it to recovery soon. Yet the economy is not only fragile, it is already cracking under the pressure of the debt overhang.

The second focus was that the economic numbers are too optimistic. But one would not have expected anything different. His forecast of -3.5 percent growth for this year and of a recession ending before the year is out are credible. Confidence is a key factor in any recovery, but one wonders whether those who have cut their discretionary spending will feel the urge to go out and spend? I doubt it. And without a rapid recovery in spending, firms will be reluctant to invest. And if the recovery is weaker, debt levels will be higher, and the pressure to curb public spending aggressively will grow. No sooner had the Chancellor sat down, than the IMF released its new forecast for the UK, of -4.1 percent this year and down -0.4% next. We expect -3.7 percent this year and sluggish growth of 0.4 percent next.

Third, the budget numbers. Six months ago the Chancellor was badly out in his projection of where the budget deficit was heading. That needs to be taken on board when you hear the Chancellor’s prediction for the fiscal outlook now. Even during the good times, when the economy’s growth was more stable and predictable, the Treasury was often out in its predictions on the budget deficit. It only takes government spending and tax revenues to be out slightly for the budget numbers to be far different from those planned.

Thus the fiscal numbers unveiled should be viewed more as a message of hope, rather than a forecast. The budget deficit, the government believes, will peak at £175 billion this fiscal year, stay around that level at £173 billion next, before heading lower to a still high £97 billion by 2013-14. But as the headline numbers fall, the government’s net debt will continue to climb, from a ratio of 55.4 percent of GDP now, to 76.2 percent of GDP by 2013-14. What if growth disappoints?

What if tax revenues are hit harder? Even on the upbeat economic views presented today the Government will have to borrow £703 billion over five years. Financial markets will not be convinced that this Budget will return public finances to a sustainable footing, as the Chancellor hopes it will.

Clearly the likelihood of an election next year, and not just the extent of the recession, had a bearing on the actual measures unveiled The Budget provided a stimulus of £5.2 billion to the economy this fiscal year of 2009-10, followed by a small tax hike of £0.1 billion in 2010-11 and a large tax hike of £5.23 billion in 2011-12, with that claw back set to continue in subsequent years.

At the time of the Pre-Budget Report I referred to it as the Good, the Bad and the Ugly: good that the Chancellor was taking timely, targeted and temporary measures to help the economy; bad that he was not doing it from a position of strength; and ugly being the fiscal position he would leave the country with. Today the picture is even uglier than before.


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