Beware the fiscal crash

THE OLD joke about God creating economists to make astrologers look credible has more than a ring of truth about it. For much of last year, economists have been revising their forecasts downwards. This time last year, the Treasury expected GDP to grow by 2.1% in 2011, picking up to 2.6% in 2012. The actual rate will be slower in 2011 than 2010, while this year is unlikely to be much better. This is the weakest upturn since before the First World War. The UK has entered the third year of recovery with GDP still more than 4% below the pre-recession peak and growth slowing.

This is very bad news for many people’s job aspirations, and for businesses’ sales and profit expectations. And for chancellor George Osborne, the weak growth trends threaten to undermine his economic objective of putting the public sector finances back on a sustainable footing. Osborne has been consistent with his commitment to Plan A for debt containment and deficit reduction. His plans to cut the cost of the public sector by £120bn have dampened growth and annoyed unions but pleased markets. The UK has held on to its coveted triple-A credit rating, with lower borrowing costs than Germany at one point in November.

But the chancellor knows that growth and deficit reduction are complementary policies, not alternatives. They go hand in hand because his tax receipts will be lower and his spending will be higher – as unemployment rises – if output increases only slowly. All his careful fiscal calculations will fall by the wayside if GDP growth comes up short.

And the dilemma he faced with his Autumn Statement last November was even more finely balanced. The best monetary cards for stimulating activity have been played. Interest rates have been at a 300-year low for nearly three years and the Bank of England has taken quantitative easing up to £275bn. Osborne was going to have to consider fiscal initiatives to kickstart the recovery – in other words to spend money or forego revenue, hoping that his measures will help close it in the medium term if the deficit widens in the short term. Getting growth on track is essential to achieve Plan A.

The chancellor delivered a broad-ranging package that touched many of the sensitive points in the economy, such as credit easing, infrastructure, housing market, petrol costs and so on. No one measure will keep growth in positive territory but, taken in aggregate, it was probably the best he could do. But the benefits will take time to feed through and some of the financial arrangements have yet to be sorted.

However, even after factoring in the impact of his proposals, the economic backdrop was as gloomy as the pessimists predicted. GDP is not expected to increase by more than 1% this year or next, unemployment and borrowing will rise, and the date by which the budget is back in balance will be delayed. And this is on the assumption that the eurozone does not disintegrate. It was not an easy message to deliver but much of the slippage is due to factors outside the government’s control. And it is fair to say that his forecast is more plausible and less politically determined than in the past.

This is not a situation of the government’s making – though it might not have won the election last year if the economy had been in better shape. But however unpopular the chancellor may be with some parts of the population, there is one important group that holds him in high esteem. The triple-A rating is worth billions to the UK in debt servicing costs – a reflection of the fact that Osborne’s policies have won the confidence of markets and preserved the country’s credit-worthiness. Other countries with lower debt levels are paying far more to borrow. Those arguing for Plan B need to bear this in mind. ?