Economic View
The Budget was a major surprise. The new chancellor, George Osborne, did what he said he was going to do. And he delivered his tough, wide-ranging speech in a confident and clear manner, writes Dennis Turner.
To reduce the £156bn annual deficit and steadily growing national debt, Alistair Darling had promised that, had Labour been re-elected, his cuts would have been more draconian than Margaret Thatcher’s in the 1980s. Osborne upped the ante by 50%, and said that almost £4 of every £5 of deficit reduction would come from spending cuts rather than tax increases.
There was no doubting that he meant business. The public sector (including pay and pensions) will bear the brunt of the spending cuts in ways that will become more apparent in October’s promised Spending Review. Benefits, the largest single item of government spending, are being scrutinised while households’ major contribution (over and above Labour’s pre-announced tax increases) was the hike in VAT to 20%. In many ways, the corporate sector came off best, in that it was punished least.
For economists, the interest lies in the implications of the package for growth, jobs, interest rates, etc. Osborne’s key messages were that the state sector is too big and that growth depends on the private sector investing and taking risks. By the end of this parliament, he clearly believes that Britain will once again be “a great place to do business”.
While the Budget certainly tightened the fiscal stance, the official forecasts for economic activity are still encouraging. The slow recovery this year (GDP increasing by 1.2% after shrinking by almost 5% in 2009) is maintained into the medium term. From 2012 to 2015, growth is expected in the range 2.7%-2.9%, even after the tax and spending changes.
To the extent that the budget will remain in deficit (albeit steadily reducing) during this parliament, fiscal policy remains stimulative. But the trade-off for the government’s tax and spending plans is that interest rates will remain low, and will probably not change at all this year.
It has been claimed that the VAT rise will hurt spending. But it does not take effect until January 2011, by which time the recovery will have lasted a solid five quarters – almost as long as the recession – and households should be in better shape. The growth forecasts, moreover, do not depend on a strong rebound in the consumer sector, and projected increases in personal spending are never more than half the rate of GDP.
Rather more worrying is the dependence the UK has on the euro zone as an export market. As it takes half of our exports, it is obvious that anything which hampers growth in Europe will hurt us. The effects of the debt problems in southern Europe will be widely spread and will dampen our prospects.
And, of course, the threat of a country actually defaulting is a worry. Banks lend money to governments and a second credit crunch could be caused by sovereign default rather than private sector debt. The risks are all on the downside.
But these are largely outside Osborne’s control. He has successfully negotiated his first hurdle and mapped out a route for a return to fiscal rectitude, without too big a compromise on growth. The next hurdles will be even higher but, so far, so good.
Dennis Turner is chief economist at HSBC
