Economics: Thanks, Darling

“Everybody’s expenditure is somebody else’s income.” This statement of the staggeringly obvious underpinned Alistair Darling’s pre-Budget report (PBR) or, as it was more accurately described by some, the Chancellor’s emergency budget. It has been variously interpreted as the death of New Labour or the return of Keynesian economics, but the PBR seemed far more prosaic and pragmatic. There is a hole in the economy where the private sector used to be, and the various measures Darling announced are an attempt to get households and businesses spending again, as well as stepping up government spending.

Too much of the subsequent comment focused on how the tax changes will be financed, the steep rise in borrowing and the jump in the ratio of public sector net debt to GDP. Government finances, already in the red, will deteriorate further and a borrowing figure of £118bn is projected for 2009-10 ­ topping £100bn for the first time. Gordon Brown had reduced the figure to 30% of GDP and wanted to keep it at a ‘sustainable’ share of 40%. But it now looks like rising to 57.4% by 2013-14, higher even than in the dark days of the Callaghan government. And these forecasts hail from a Treasury with a track record for optimism on public sector finances.

If not dead, ‘prudence’ is taking a very long holiday. Brown’s golden rules are now totally irrelevant and the claim that boom-and-bust cycles have been consigned to the history books looks a bit premature. But none of this means Darling’s PBR got it wrong. The worst that might be said is that, if he intended loosening fiscal policy, he really should not have started from here. His problem was his inheritance, hardly a robust one. He, nevertheless, still needed to respond decisively to what will almost certainly be confirmed a recession by the time you read this.

Respond he did. In some ways he was very modest, given the scale of the problems. The housing market is still sliding south, the cries of anguish from the high street are getting louder, the car industry wants government help and the much-watched Purchasing Managers’ Index surveys in manufacturing, services and construction have all recorded their lowest-ever readings. As unemployment rises and the impact of the credit crunch is now being felt by households and small businesses, the Chancellor had to point the way to recovery.

Spread over two fiscal years, it is estimated he will inject the equivalent of 1% of GDP into the economy, not enough to prevent a recession or a very tough 2009. But, taken in conjunction with other initiatives, the PBR should minimise its length and depth. The effectiveness of individual measures, such as the reduction of VAT to 15%, can be debated. But direction of policy was essential. As consumers retrench, leading businesses to cut back, a stimulus from the public sector is essential. The impact on public finances, moreover, is not as draconian as some parts of the media claim. If net debt does rise to 57.4%, it will still be lower than Germany’s, France’s and the US’s today, less than half of Italy’s and one-third of Japan’s. Some of it is to be repaid by the banks and, given low interest rates, the debt is affordable.

On its own, the PBR will not bring forward the date of an upturn by very much. But this looser fiscal policy will complement the looser money policy already in place. It means all available policy levers are now being pulled at the same time. The MPC decision to reduce Bank Rate to 3% last November was worth £45 each month in disposable income for every £50,000 of debt (assuming the rate cuts were passed on) ­ and the Committee cut it by a further percentage point on 4 December to 2.0%, its lowest level since 1951.

But despite upsetting those holidaying abroad, the recent slide in sterling is a plus for the economy. There is a need to re-balance activity, with more exports required instead of consumption. In a slowing global economy, British firms need an edge and the weaker sterling will help them look more competitive to foreign buyers.

Anyone still doubting the authorities’ actions should look back to September 1992. Once the UK was humiliatingly dumped out of the ERM, interest rates fell from double-digit rates and sterling settled at a much lower level, while Chancellor Norman Lamont had already stepped up public sector spending. This combination of actions quickly led to the end of the recession and ushered us into a 16-year period of growth. Today, the Treasury, MPC and the currency market have adopted the same package of measures, even earlier in the cycle.

The Major government, hamstrung by ERM membership, was not free to act before the debacle of 16 September 1992. Today, however, the necessary steps were taken before the UK was officially announced to be in recession, which is why the downturn should be a ‘V’ shape, rather than a ‘U’ or even an ‘L’. Darling’s PBR should not be seen in isolation but as part of concerted attempt to get the economy moving again.