By Peter Riddell
4 February 2010
The recession is officially over. But the misery will continue when the next government has to decide between continuing economic life support or paying off the debt. Peter Riddell asks which party has a credible plan
The official end of the 18-month-long recession, if only by a whisker, is a cause for both relief (though hardly celebration) and uncertainty. It’s likely to be a rocky road to recovery.
Far from being the end of the worst phase, it marks the beginning of a much trickier one for policy-makers – and for the parties ahead of the general election. When and how quickly should the relaxation in fiscal and – don’t forget – monetary policy be reversed? On these questions, both the Conservatives and Labour are vague.
For a start, the shift is hardly massive. Growth of 0.1% in the final three months of last year could easily be revised in either direction, and it follows a record contraction of 4.8% during 2009. It all looks rather fragile, with consumer confidence weak and worries that the economy could easily slide back in the first quarter of this year. On the other hand, unemployment has fallen. No wonder that the shrewd Richard Lambert, director-general of the CBI business lobby, has warned that it might take two years for the economy to get back to where it was before the financial crisis. Credit is still not flowing, real pay is being squeezed, and companies are being cautious about their expansion plans. ‘It’s going to take time before the animal spirits start pulsing again,’ he has argued. So there are fears about a ‘double dip’ recession.
That highlights the acute dilemma of what the authorities should do now. In many ways, the period from autumn 2008 to this January was, by comparison, straightforward. The government was criticised by the Tories over some of its fiscal stimuli, but, otherwise, there was general endorsement of the ‘whatever it takes’ theme of using all available monetary and fiscal tools — including some previously unused ones — to stabilise the financial system and to mitigate the effects of the recession, particularly on unemployment.
A large part of the banking system was nationalised and huge guarantees were made by the state; special help was offered to vulnerable sectors such as the car industry and housing; VAT was temporarily cut; and public spending projects were brought forward. And, more important than the limited fiscal expansion, the money supply was expanded through quantitative easing once interest rates had touched bottom and could be lowered no more. A major uncertainty this year will be how rapidly the Bank of England reverses quantitative easing after the recent meeting of the Monetary Policy Committee, since this will have big implications for interest rates and the price at which the government will be able to sell gilt-edged stock to fund its huge deficit.
These actions, both in Britain and overseas, did help to prevent any repeat of the 1930s depression and have limited the length and depth of the recession. Unemployment, particularly among young people, has risen sharply, but it could have been a lot worse.
However, a price was always going to have to be paid. The big rise in the budget deficit to more than 12% of national income will not all be eliminated as the economy recovers and tax receipts pick up. There is also a very large structural deficit. The Treasury itself now admits that during the good years it was over-optimistic about the underlying growth of the economy and tax revenues: it mistook some of the buoyancy of receipts for a sustainable rise. Moreover, the upheavals in financial services have left a big hole in tax revenues, which will not be filled quickly.
All parties accept that action must be taken to reduce the underlying deficit. The dispute is over when and how. Despite highlighting the start of the recovery, Chancellor Alistair Darling has warned of the continuing fragility of the economy, which must not be put in jeopardy by premature cutbacks in public spending. This is likely to be a major theme of his Budget, expected in March. Hence, while the objective is to cut the deficit in half over the next four years, this process will start only in 2011.
Paradoxically, the weakness of the fourth quarter figures has reinforced Darling’s case: business and consumers need all the help they can get. However, contrary to public statements, ministers have already reversed the biggest fiscal expansion of the recession by putting VAT up to 17.5% again at the turn of the year, as well as announcing the end of the car scrappage scheme. To demonstrate the Treasury’s seriousness about deficit reduction, Liam Byrne, the chief secretary, has written to departments to propose detailed savings from 2011 onwards and to rank spending priorities.
By contrast, the Conservatives argue that the debt crisis is the biggest threat to recovery, and that the economy will only really recover if ‘we start right now on a proper debt reduction plan’. Leader David Cameron has used the folksy comparison: ‘It’s like a credit card—the more we spend and the longer we wait to pay off our bills, the worse it can get.’ He has drawn the comparison with Greece, whose credit rating has been downgraded.
Vince Cable, for the Liberal Democrats, has summed up the contrasting pressures. One is to keep ‘the infusion of monetary steroids and fiscal resuscitation techniques until the patient is clearly past the danger point’. The other is to prevent a budgetary crisis that will arise if international bond markets lose confidence in the government’s capacity to sustain its borrowing and debt obligations.
This could result in a downgrading of sovereign risk rating and/or a sharp increase in borrowing costs.
These differences can be exaggerated. There is agreement on the long-term direction: cutting the budget deficit without jeopardising recovery. In practice, there is a limited amount that an incoming Conservative government can do on the spending side in 2010/11 since the financial year will already have started – Cameron recognised this in saying there would be no ‘swingeing’ or ‘particularly extensive’ cuts this year. This was in response to evidence of a sluggish economy.
Cameron has talked of bringing in an emergency Budget within weeks of taking office, though all new governments introduce Budgets shortly after they take over: Geoffrey Howe did in 1979 and Gordon Brown did in 1997. Lord Howe of Aberavon, as he now is, announced a squeeze on spending plans in 1979/80, but these were relatively small scale by comparison with cuts in later years.
George Osborne, the shadow chancellor, has said early measures would involve a halt both to child tax credits for those earning over £50,000 and to child trust funds for all but the poorest families and disabled children. In addition, administrative costs would be squeezed with savings on consultants and advertising. These will be largely symbolic.
The only fiscal options that can make a big difference in the short term are on the tax side — for instance, by raising VAT to 20%, which would bring in substantial amounts of money. But the Tories might be cautious on that front. They have indicated that three-quarters to four-fifths of the fiscal adjustment should come from reduced spending plans rather than tax increases. Also, another VAT increase might further damage consumer confidence and spending.
The real question for a Cameron government or a re-elected Brown government is whether they have a credible longer-term plan for deficit reduction. In both cases, they are long on aspiration and short on detail. The Pre-Budget Report set out plans to halve the deficit over four years but, after making commitments to real spending growth on the ‘frontline’ NHS, schools and Sure Start for 2010/11 and 2012/13, it said little about how the pain would be distributed elsewhere. The Institute for Fiscal Studies has estimated that other departmental budgets would need to shrink by 5.6% a year on average over the three years of the Spending Review.
The strong emphasis on fiscal adjustment made by the Tories will, they hope, give them the political authority and mandate for tough decisions. These would be taken early on, in a Spending Review during the summer with announcements in the autumn. Such decisions would mainly have an impact in later years. Indeed, Conservative shadow spokesmen talk about becoming the most unpopular government in living memory within months of taking office. That is fine if the Tories have a secure working majority of more than, say, 30 to 40 in the Commons and therefore can expect a full four- to five-year Parliament.
However, what happens if there is a hung Parliament? Financial commentators have recently suggested there might be panic in the markets if this happened because of the fear that a minority administration would not be able to act decisively. These worries are greatly exaggerated. We have such a majoritarian culture at Westminster that it is often forgotten that minority administrations and coalitions are the norm in many western democracies, notably those with proportional representation, and these have proved capable of taking tough fiscal action. A minority Cameron government would be in a strong position to introduce tough measures, proclaiming the national interest and challenging other parties to support a deficit reduction plan.
Nick Clegg has said the Liberal Democrats would back ‘significant cuts’. While there are differences of detail with the Tories — for instance, on replacing the Trident nuclear deterrent — there are also wide areas of agreement, such as reforming public sector pensions, cutting back the child trust fund and tax credits for the better-off.
So far, the Tories have identified only a first instalment: a public sector pay freeze, except for those earning under £18,000 a year: capping public sector pensions; cutting the costs of ‘Whitehall bureaucracy’ and quangos; and bringing forward the start of the increase in the state pension age. But these do not go anywhere near bridging the deficit gap, especially if the path of reduction is to be faster.
Indeed, for all the talk of coming in with business plans and detailed implementation schemes, the Tories are vague about how they intend to cut spending. The civil service is further advanced in preparing big cuts options of 15% to 20% or more.
The Tories have argued that fiscal consolidation, as it is euphemistically called, needs to be accompanied by a restructuring of the state based around the principles of ‘decentralisation, accountability and transparency’. That is common across the parties. But what does the Tories’ talk of the post-bureaucratic state mean in practice? Will localism mean a genuine devolution of decision making to the local level or will the priority of cutting spending come first?
The Tories favour greater individual choice in services such as education and health and payment by results by independent providers in prison rehabilitation, drug treatment and welfare-to-work. So the result would not just be a smaller state, as measured by public spending, but also a different state – with fewer services being provided by state agencies and more by the private and voluntary sectors.
But can these structural changes be introduced within the Tories’ goal of not adding to expenditure?
Of course, there are big differences between the parties in priorities, in the balance between higher taxes and lower spending. But there is an expectation that the next Parliament will be characterised both by an awkward period of economic recovery and by a painful contraction in the size and scope of the state.
Peter Riddell is chief political commentator of The Times and a senior fellow of the Institute for Government
4 February 2010
The recession is officially over. But the misery will continue when the next government has to decide between continuing economic life support or paying off the debt. Peter Riddell asks which party has a credible plan
The official end of the 18-month-long recession, if only by a whisker, is a cause for both relief (though hardly celebration) and uncertainty. It’s likely to be a rocky road to recovery.
Far from being the end of the worst phase, it marks the beginning of a much trickier one for policy-makers – and for the parties ahead of the general election. When and how quickly should the relaxation in fiscal and – don’t forget – monetary policy be reversed? On these questions, both the Conservatives and Labour are vague.
For a start, the shift is hardly massive. Growth of 0.1% in the final three months of last year could easily be revised in either direction, and it follows a record contraction of 4.8% during 2009. It all looks rather fragile, with consumer confidence weak and worries that the economy could easily slide back in the first quarter of this year. On the other hand, unemployment has fallen. No wonder that the shrewd Richard Lambert, director-general of the CBI business lobby, has warned that it might take two years for the economy to get back to where it was before the financial crisis. Credit is still not flowing, real pay is being squeezed, and companies are being cautious about their expansion plans. ‘It’s going to take time before the animal spirits start pulsing again,’ he has argued. So there are fears about a ‘double dip’ recession.
That highlights the acute dilemma of what the authorities should do now. In many ways, the period from autumn 2008 to this January was, by comparison, straightforward. The government was criticised by the Tories over some of its fiscal stimuli, but, otherwise, there was general endorsement of the ‘whatever it takes’ theme of using all available monetary and fiscal tools — including some previously unused ones — to stabilise the financial system and to mitigate the effects of the recession, particularly on unemployment.
A large part of the banking system was nationalised and huge guarantees were made by the state; special help was offered to vulnerable sectors such as the car industry and housing; VAT was temporarily cut; and public spending projects were brought forward. And, more important than the limited fiscal expansion, the money supply was expanded through quantitative easing once interest rates had touched bottom and could be lowered no more. A major uncertainty this year will be how rapidly the Bank of England reverses quantitative easing after the recent meeting of the Monetary Policy Committee, since this will have big implications for interest rates and the price at which the government will be able to sell gilt-edged stock to fund its huge deficit.
These actions, both in Britain and overseas, did help to prevent any repeat of the 1930s depression and have limited the length and depth of the recession. Unemployment, particularly among young people, has risen sharply, but it could have been a lot worse.
However, a price was always going to have to be paid. The big rise in the budget deficit to more than 12% of national income will not all be eliminated as the economy recovers and tax receipts pick up. There is also a very large structural deficit. The Treasury itself now admits that during the good years it was over-optimistic about the underlying growth of the economy and tax revenues: it mistook some of the buoyancy of receipts for a sustainable rise. Moreover, the upheavals in financial services have left a big hole in tax revenues, which will not be filled quickly.
All parties accept that action must be taken to reduce the underlying deficit. The dispute is over when and how. Despite highlighting the start of the recovery, Chancellor Alistair Darling has warned of the continuing fragility of the economy, which must not be put in jeopardy by premature cutbacks in public spending. This is likely to be a major theme of his Budget, expected in March. Hence, while the objective is to cut the deficit in half over the next four years, this process will start only in 2011.
Paradoxically, the weakness of the fourth quarter figures has reinforced Darling’s case: business and consumers need all the help they can get. However, contrary to public statements, ministers have already reversed the biggest fiscal expansion of the recession by putting VAT up to 17.5% again at the turn of the year, as well as announcing the end of the car scrappage scheme. To demonstrate the Treasury’s seriousness about deficit reduction, Liam Byrne, the chief secretary, has written to departments to propose detailed savings from 2011 onwards and to rank spending priorities.
By contrast, the Conservatives argue that the debt crisis is the biggest threat to recovery, and that the economy will only really recover if ‘we start right now on a proper debt reduction plan’. Leader David Cameron has used the folksy comparison: ‘It’s like a credit card—the more we spend and the longer we wait to pay off our bills, the worse it can get.’ He has drawn the comparison with Greece, whose credit rating has been downgraded.
Vince Cable, for the Liberal Democrats, has summed up the contrasting pressures. One is to keep ‘the infusion of monetary steroids and fiscal resuscitation techniques until the patient is clearly past the danger point’. The other is to prevent a budgetary crisis that will arise if international bond markets lose confidence in the government’s capacity to sustain its borrowing and debt obligations.
This could result in a downgrading of sovereign risk rating and/or a sharp increase in borrowing costs.
These differences can be exaggerated. There is agreement on the long-term direction: cutting the budget deficit without jeopardising recovery. In practice, there is a limited amount that an incoming Conservative government can do on the spending side in 2010/11 since the financial year will already have started – Cameron recognised this in saying there would be no ‘swingeing’ or ‘particularly extensive’ cuts this year. This was in response to evidence of a sluggish economy.
Cameron has talked of bringing in an emergency Budget within weeks of taking office, though all new governments introduce Budgets shortly after they take over: Geoffrey Howe did in 1979 and Gordon Brown did in 1997. Lord Howe of Aberavon, as he now is, announced a squeeze on spending plans in 1979/80, but these were relatively small scale by comparison with cuts in later years.
George Osborne, the shadow chancellor, has said early measures would involve a halt both to child tax credits for those earning over £50,000 and to child trust funds for all but the poorest families and disabled children. In addition, administrative costs would be squeezed with savings on consultants and advertising. These will be largely symbolic.
The only fiscal options that can make a big difference in the short term are on the tax side — for instance, by raising VAT to 20%, which would bring in substantial amounts of money. But the Tories might be cautious on that front. They have indicated that three-quarters to four-fifths of the fiscal adjustment should come from reduced spending plans rather than tax increases. Also, another VAT increase might further damage consumer confidence and spending.
The real question for a Cameron government or a re-elected Brown government is whether they have a credible longer-term plan for deficit reduction. In both cases, they are long on aspiration and short on detail. The Pre-Budget Report set out plans to halve the deficit over four years but, after making commitments to real spending growth on the ‘frontline’ NHS, schools and Sure Start for 2010/11 and 2012/13, it said little about how the pain would be distributed elsewhere. The Institute for Fiscal Studies has estimated that other departmental budgets would need to shrink by 5.6% a year on average over the three years of the Spending Review.
The strong emphasis on fiscal adjustment made by the Tories will, they hope, give them the political authority and mandate for tough decisions. These would be taken early on, in a Spending Review during the summer with announcements in the autumn. Such decisions would mainly have an impact in later years. Indeed, Conservative shadow spokesmen talk about becoming the most unpopular government in living memory within months of taking office. That is fine if the Tories have a secure working majority of more than, say, 30 to 40 in the Commons and therefore can expect a full four- to five-year Parliament.
However, what happens if there is a hung Parliament? Financial commentators have recently suggested there might be panic in the markets if this happened because of the fear that a minority administration would not be able to act decisively. These worries are greatly exaggerated. We have such a majoritarian culture at Westminster that it is often forgotten that minority administrations and coalitions are the norm in many western democracies, notably those with proportional representation, and these have proved capable of taking tough fiscal action. A minority Cameron government would be in a strong position to introduce tough measures, proclaiming the national interest and challenging other parties to support a deficit reduction plan.
Nick Clegg has said the Liberal Democrats would back ‘significant cuts’. While there are differences of detail with the Tories — for instance, on replacing the Trident nuclear deterrent — there are also wide areas of agreement, such as reforming public sector pensions, cutting back the child trust fund and tax credits for the better-off.
So far, the Tories have identified only a first instalment: a public sector pay freeze, except for those earning under £18,000 a year: capping public sector pensions; cutting the costs of ‘Whitehall bureaucracy’ and quangos; and bringing forward the start of the increase in the state pension age. But these do not go anywhere near bridging the deficit gap, especially if the path of reduction is to be faster.
Indeed, for all the talk of coming in with business plans and detailed implementation schemes, the Tories are vague about how they intend to cut spending. The civil service is further advanced in preparing big cuts options of 15% to 20% or more.
The Tories have argued that fiscal consolidation, as it is euphemistically called, needs to be accompanied by a restructuring of the state based around the principles of ‘decentralisation, accountability and transparency’. That is common across the parties. But what does the Tories’ talk of the post-bureaucratic state mean in practice? Will localism mean a genuine devolution of decision making to the local level or will the priority of cutting spending come first?
The Tories favour greater individual choice in services such as education and health and payment by results by independent providers in prison rehabilitation, drug treatment and welfare-to-work. So the result would not just be a smaller state, as measured by public spending, but also a different state – with fewer services being provided by state agencies and more by the private and voluntary sectors.
But can these structural changes be introduced within the Tories’ goal of not adding to expenditure?
Of course, there are big differences between the parties in priorities, in the balance between higher taxes and lower spending. But there is an expectation that the next Parliament will be characterised both by an awkward period of economic recovery and by a painful contraction in the size and scope of the state.
Peter Riddell is chief political commentator of The Times and a senior fellow of the Institute for Government
