Today’s Budget ranks as the most important in 30 years. That is no hyperbole, for the problems that it will address stem from the greatest economic crisis since the 1930s. In his speech, George Osborne, the Chancellor, will explain how the Lib-Con coalition intends to put the public finances back on a sustainable footing.
A credible plan must involve deep and early cuts in public spending. The Labour Opposition and some influential economists maintain that such a course risks tipping the economy back into recession when recovery is uncertain. That argument is not frivolous but it is misguided. The risks of postponing spending cuts outweigh the risks of withdrawing demand from the economy.
There is a precedent for these arguments. Sir Geoffrey Howe, then the Conservative Chancellor, adopted highly restrictive policies — raising taxes by nearly 2 per cent of GDP — in his 1981 Budget to remedy an expanding deficit. Doing this in a severe recession, he violated the economic orthodoxy of the time, which urged an expansion of borrowing to sustain demand. The Times published a letter from 364 economists a month afterwards criticising these austere measures. Nigel Lawson, Lord Howe’s successor, later noted: “Their timing was exquisite. The economy embarked on a prolonged phase of vigorous growth almost from the moment the letter was published.”
The argument for a sharply contractionary Budget now is more compelling still, because the extent of fiscal deterioration is greater. The near-collapse of the Western banking system in 2008 caused a deep recession, to which governments responded with a big monetary and fiscal stimulus. A second Great Depression was averted, but the experience has left scars on the economy.
The budget deficit for this year is forecast by the new Office for Budget Reponsibility (OBR) to be £155 billion, or more than 10 per cent of GDP. The forecast deficit in 1980-81 represented 6 per cent of GDP, which contractionary policies managed to reduce to 4¼ per cent. And the most worrying feature of the current fiscal position is the size of the structural deficit. The OBR estimates this as £123 billion. The structural deficit is the part of the deficit that will not be corrected automatically as the economy recovers; it can be eliminated only by tax rises and spending cuts, or both.
Advertisement
The last Government did not cause the recession, but fiscal irresponsibility ensured that Britain entered it in a weak position. The share of public spending in GDP rose from just under 40 per cent to 48 per cent between 1997 and 2007, while the economy was growing briskly. That rise testified to a huge error by Gordon Brown, the Chancellor throughout that time, in believing that he had tamed the business cycle. Britain had little scope for the fiscal expansion made necessary by the recession. That expansion now needs to be offset by a still greater contraction. Consumers know this; hence any delay in cutting spending is likely to be ineffective in supporting demand, as households will build up their precautionary savings for the inevitable squeeze on living standards.
The UK is still far from entering a “debt trap”, where the interest rates on its debt would exceed the growth rate of the economy. That would ensure a rapid accumulation in the debt burden, as has happened to Greece. But no one knows how close that prospect is for the UK, and markets will worry about it long before it arrives.
Investors have been counting on a new government to tighten fiscal policy, and it is for that reason that long-term interest rates have not yet shot up. They will do so if confidence in the Government’s budgetary discipline evaporates. Mr Osborne might recall, and is highly unlikely to ignore, Margaret Thatcher’s advice to the first President Bush in other circumstances: remember, George, this is no time to go wobbly.