27 March 2009
Peace is not about to break out at the G20 summit. There are deep divisions over the size of the global fiscal stimulus — mirrored by clashes between Numbers 10 and 11. Peter Riddell takes some soundings
The G20 summit in London on April 2 is absorbing vast amounts of political energy, as well as prime ministerial time. Gordon Brown is leaving a huge carbon footprint as he travels around Europe, and twice across the Atlantic, flying as far as Chile to secure prior commitments to action from the world leaders attending.
The meeting will last only a few hours, giving each leader just a few minutes to make a contribution. It will be more theatre and global photo-opportunity than seminar or negotiation, with the details of the communique all carefully prepared in advance.
The main interest will be in the first visit of Barack Obama to London as president, his meeting with the Queen and his travels around the capital. His huge entourage will aggravate a logistical nightmare as 30-plus leaders and heads of international organisations travel from central London to the Docklands for the meeting. Stories about London gridlock might get the headlines rather than the substance of the summit.
The summit is hardly going to change the course and timing of the recession. But the outcome could still have an impact on the Budget three weeks later. No-one expects such a large, and brief, summit to be a turning point. It is certainly unlikely to achieve the significance of the 1944 Bretton Woods meeting, which led to the establishment of the International Monetary Fund and the World Bank, as well as the post-war financial system that lasted for a quarter of a century.
At most, the London summit, which will be attended by the leaders of the 20 top industrial nations, will be remembered as one in a series of meetings this year intended to foster recovery, to produce an improved framework of regulations and reorganise international financial institutions to take account of the rise of China and India.
In the short term, what matters is what is said in the final communique about actions needed to end the recession. This is directly relevant to a vigorous debate going on at present between Number 10 and the Treasury over what should be in the Budget on April 22, fuelled by Bank of England governor Mervyn King’s caution over a further fiscal stimulus.
Brown is keen to put the argument in international terms. For him, the banking crisis and recession are global stories requiring international solutions. But the responses to them are affected not just by global factors but by domestic circumstances. Brown is keen to gloss over such national differences, so he can justify any British actions in the April Budget as being in line with what is happening elsewhere.
Such international co-ordination is hard to achieve since, in any recession, the prime movers are still national governments. They will do what they believe is in their countries’ interests rather than act in accordance with some globally agreed plan. The limitations of such co-ordinated action were shown more than 30 years ago at the Bonn summit of what was then the Group of Seven, which agreed fiscal plans based on the ‘locomotive’ theory fashionable at the time. On this basis, the strong pulled along the weak. In retrospect, the boosts came too late and led to higher inflation all round.
At present, there have been disagreements both within the European Union – underlined at the summit of EU leaders on March 19–20 – and between Europe and the US about what and how much to do. Earlier this month, EU finance ministers rebuffed calls by the US for much more government action to stimulate ailing economies. Luxembourg prime minister Jean-Claude Juncker, who chairs the group of countries within the eurozone (excluding, of course, Britain), said on March 9 that the 16 finance ministers had agreed that ‘recent American appeals insisting that Europeans make an added budgetary effort were not to our liking’.
Differences were later smoothed over at a meeting of the G20 finance ministers in Sussex on March 13–14, chaired by UK Chancellor Alistair Darling. The resulting communique took the bland stance that participants had pledged to ‘take whatever action is necessary until growth is restored’. The emphasis was more on strengthening financial regulation and substantially increasing the resources available to the IMF.
Beneath the surface, however, differences remained. Tim Geithner, the beleaguered US treasury secretary, played down an earlier American proposal for countries to introduce a fiscal stimulus equivalent to 2% of national income in 2009 and 2010. But he argued that, ‘with all the major economies… putting in place substantial fiscal packages’, the ‘stronger the response, the quicker recovery will come’. By contrast, Peer Steinbruck, the German finance minister, said: ‘We are convinced it makes no sense to pump more and more money into our economy when we haven’t restored confidence in financial markets.’
Part of the problem is defining the size of any stimulus. This is not just an arcane economists’ point. It is fundamental to what is happening. There are two basic components. The first consists of the automatic stabilisers: that is, the increase in spending on unemployment and welfare benefits and the like that occurs when an economy slows and goes into a recession. At the same time, tax revenues fall because of the slower activity. Both trends boost public borrowing and governments tend not to offset such cyclical pressures in the belief that they will be reversed when the economy recovers.
The second component is discretionary: increases in spending or cuts in taxation on top of the automatic stabilisers to minimise the impact of the recession and to accelerate recovery. In Britain, for example, the government has announced spending on various schemes to help the housing sector and small businesses, as well as the temporary cut in VAT, which costs more than £12bn a year.
It makes a big difference if you look at the total change in fiscal policy or just the discretionary element. For instance, Darling’s statement to the Commons on March 16, after the meeting of the G20 finance ministers, quoted IMF estimates that this year’s fiscal stimulus in the US is worth 3.5% of national income; in Germany 3.2%; in China and France 2.6%; and in Britain 3.4%. However, in his Pre-Budget Report last November, he talked of a fiscal stimulus between then and April 2010 amounting to around 1% of national income. The recent estimate referred to the automatic and discretionary elements combined, and the earlier figure was just the discretionary figure. While, as Darling indicated, the scale of total stimulus action is roughly comparable between the main countries (see figure 2), there are big differences in the scale of discretionary action. The IMF estimates that, while the US has so far introduced spending and tax measures (notably the package signed last month by President Obama) amounting to 2% of national income, the figures for Germany and Britain were around 1.5%, and just 0.7% for France. (The 2009 figure for Britain is higher than the Pre-Budget Report estimate of 1% for 2009/10 since VAT will return to its previous level after this Christmas for the final three months of the financial year.)
Looked at another way, while the automatic stabilisers are worth about 2% of national income in Britain and France, they amount to just 1.5% in the US. This difference is because the welfare states are larger in Europe than in the US. The interesting point is why Darling chose to emphasise the larger figure, including the automatic stabilisers. This is partly because he wanted to highlight the extent of transatlantic agreement and to minimise differences on stimulus packages ahead of the full G20 summit. This recognises that there are limits to co-ordination and exhortation.
Darling was also delivering a domestic message. The higher stimulus figure also enables him to claim that Britain is already doing a lot, as much as the US, and perhaps does not need another big stimulus package in the Budget, a view reinforced by King’s intervention. This is the dividing line with Number 10. Brown has been talking about the need for further action. He told a meeting of business leaders in London on March 18 that world efforts to tackle the crisis were not enough and more needed to be agreed at the G20 summit. In practice, the wording in the April 2 communique is likely to be ambiguous, allowing countries to do what they want to do anyway. But the thrust might allow Brown to argue for a further stimulus.
The Treasury is cautious not just because Britain has already done a lot to combat the recession, but because of the high level of existing public borrowing. In short, even when the economy recovers from some time in 2010 onwards, the structural budget deficit will be very large and will require several years of a tight fiscal squeeze to correct. This will probably involve both higher taxes and much slower spending growth.
The problem has been aggravated by the upheaval in the banking and financial services sector, which previously paid very large amounts in tax revenues. The disappearance of these receipts is unlikely to be reversed quickly since most analysts expect this sector to be smaller than before and therefore paying less in tax. Filling that gap is a major headache for the Treasury.
Consequently, Darling’s advisers are worried about ‘giving too much away’ now because of how much they will have ‘to take back’ later. There are certain to be some stimulus measures in the Budget but they might be aimed at particular groups who are being hit now, such as older people relying on savings. They are suffering not only from the fall in the stock market but also, in particular, from very low interest rates. There might also be targetted spending measures, notably on low carbon and high technology projects.
But, at the same time, the Treasury is also looking for substantial savings in spending over the medium term. A figure of £5bn has been mentioned for the coming year, though this will be partially offset by extra short-term spending on anti-recession measures. So there is the strange process whereby departments are, on the one hand, being asked to find savings, and, on the other hand, eagerly trying to find projects to fit into any stimulus programme.
But this is just preliminary skirmishing ahead of the main battles over public spending. It is now unlikely that there will be a Comprehensive Spending Review this year to decide on levels beyond the end of the current planning period in April 2011. There is likely to be a huge review in summer 2010 after the election. This is ostensibly because of the current big uncertainties over the course of the economy. But, in practice, the main reason is political since the government is unlikely to want to commit itself to what will be very tough decisions and cutbacks ahead of a general election. At most, there might be commitments on favoured areas such as health and schools.
By the time the crunch comes, all this summer’s activity and the G20 summit will have been long forgotten. But the horizon of Brown and the other G20 leaders at present is much shorter term: how to get out of the economic and financial crisis.
