By Tash Shifrin
25 June 2009
The UK government will be running a level of deficit normally associated with a ‘banana republic’ for the next year or so, a leading economist has warned.
Willem Buiter, professor of European political economy at the London School of Economics, issued his verdict at the CIPFA conference on June 24 as Bank of England governor Mervyn King hit out at the ‘truly extraordinary’ scale of the deficit.
The Organisation for Economic Co-operation and Development also released a gloomy outlook statement on the UK’s economic prospects.
Buiter, formerly a member of the Bank of England’s monetary policy committee and chief economist at the European Bank for Reconstruction and Development, told CIPFA delegates that government deficits of more than 12% of GDP were usually seen in economies characterised as ‘banana republics’. He warned: ‘We’re going to see [that] here and in the US for the next year or so.’ The financial crisis had been ‘the most serious’ since the 1930s, Buiter said, and the global economic contraction was following ‘with almost mathematical precision’ the pattern of the Great Depression.
History showed that where a contraction in the economy followed a financial crisis, it was ‘deeper and longer than regular recessions’, he said, adding: ‘Government debt explodes when recession follows a financial crisis.’
Buiter said the UK’s soaring debt figures were ‘not primarily the cost of recapitalising the banks... By far the largest share is due to the collapse of government revenues’.
The Treasury’s tax receipts had been hit by the collapse in profits in the financial sector and loss of revenues from capital gains tax and stamp duty because of the decline of the housing sector. He told delegates: ‘The buoyancy of taxes... is going to be permanently lower.’
Appearing before the Treasury select committee, King said: ‘The scale of the deficit is truly extraordinary.’
A figure of 12.5% of GDP reflected the scale of the global downturn, he said. ‘But it also reflects the fact that we came into this crisis with fiscal policy itself on a path that wasn’t itself sustainable.’
He called for ‘a plan for the lifetime of the next Parliament’ to bring deficit levels down ‘below those which were shown in the Budget figures’.
The OECD predicted UK output would ‘decline by 4.3% in 2009 and recover only mildly in 2010’, painting a bleaker picture than Chancellor Alistair Darling’s Budget prediction of a 3.5% fall in GDP this year.
It added: ‘At the same time, public finances have deteriorated sharply – with the fiscal deficit expected to rise to 14% of GDP in 2010, curtailing possibilities for additional fiscal stimulus.’
