Economics - Waive the rules: will the Budget succeed in changing the direction of our economy?

Few Chancellors have gone into the Budget speech with such a
weak hand to play as Alistair Darling. As his pre-Budget report (PBR) last
November revealed, public finances are probably the biggest long-term casualty
of the recession. GDP growth will be back in positive territory in 2010 and
unemployment will stop rising a little later, while the housing market is
already showing some signs of life (straws in the wind, though, rather than
green shoots). But even before the full extent of the banking rescue packages
was factored in, it was clear from the PBR that the costs of the various
initiatives to counter the recession would stretch into the middle of the next
decade.

Gordon Brown arrived at the Treasury in 1997 full of good intentions, and
prudence was his watchword. He did not want to be thought of as the sort of
reckless tax-and-spend Labour Chancellor that wrecked the public finances in the
past. Prudence was enshrined in two fiscal rules: The Golden Rule (only
borrowing to invest) meant the current budget had to be in surplus over the life
of the cycle, while the Sustainable Investment Rule meant keeping net debt at a
stable and sustainable share (40%) of GDP.

Although questions can reasonably be asked about the relevance of these
rules, they are the yardsticks by which Brown wanted to be judged and the extent
to which the targets have been missed is one way of assessing the government’s
fiscal record.

As Darling made clear in this latest Budget, the fiscal rules are consigned
to the history books. It is probably not unfair to say his weakness has, in
fact, been his inheritance, because Brown’s idea of prudence was five
consecutive years of current budget deficits and a steady rise in the debt-GDP
ratio at a time when the economy was growing. When the economy turned down and
the Chancellor needed to ease fiscal policy to stimulate activity, there was
nothing in the kitty to spend.

The Budget book reveals the full extent of the damage to the public purse. In
2007-08, government borrowing was £35bn. Just two years later, because of much
weaker tax receipts and higher social security spending together with the
measures to counter recession, borrowing is up to an unprecedented £175bn, or
12% of GDP. This is the first time the number has topped £100bn. Even next year,
Darling believes borrowing will be about the same and not until 2013-14 does he
expect it to dip below £100bn. As a share of GDP, net debt will rise to 76% in
four years’ time – virtually double Brown’s original rule.

Reducing this huge imbalance requires bold action with a mix of reduced
government spending and higher taxes. Darling’s task was to point the way to a
healthier fiscal future while still exuding confidence about the short-term
economic outlook, offering tax and spending incentives to counter the recession.

He really did not deliver. While the borrowing numbers were not really a
surprise, the real disappointment was the lack of clear signposts as to how
public finances will be brought back into reasonable shape.

The Chancellor made it clear that cutting spending is not on his agenda.
Wielding the axe now would make recession worse. On the revenue front, the
headline announcement was a 50% tax rate on earnings in excess of £150,000.
Since this measure affects no more than a million people and raises just £2bn,
it is hard not to see it as a largely political move to embarrass the
Conservatives a year or so before a general election. The overall feeling is
that this is essentially a political Budget and the really bad news is being
held back until after the next election.

If the fiscal changes were a damp squib, the economic assumptions were a
cause for concern. The tax and spending plans are dependent on the growth of the
economy and, as ever, the Treasury is at the optimistic end of the range.

While admitting this will be the worst year for growth since 1945, Darling s
aid he expected the recovery to start by the end of this year. In 2010, GDP
should be rising at an annual rate of 1% to 1.5% and by an above-trend 3.5% in
2011; a very strong recovery. But few independent forecasters are as upbeat. The
consensus for next year is for GDP to rise, but by less than 0.5%. If, however,
growth comes up short of Darling’s forecasts, tax receipts will be down,
spending up and borrowing even higher.

Without doubt, Darling’s delivery was lower key, more modest and more
transparent than his predecessor’s, but this only served to expose the lack of
substance in his speech. And for all the brouhaha surrounding the Budget, the
net changes amount to tinkering at the margin. Darling said his measures added
up to a fiscal easing of 0.5% of GDP this year and a tightening of 0.8%
thereafter, until 2013-14. This is hardly enough to change the direction of
economic activity or to address the fundamental fiscal imbalances where
borrowing is 12% of GDP. At the end of the day, it was much ado about very
little.