It is difficult to overdramatise the danger that is engulfing our country. In some ways our position is more precarious than in 1940 when we stood alone against the Nazi tyranny.
The danger can be stated easily enough. Far from building up reserves during the latter stages of the boom, the government went on a borrowing spree amounting to £200 billion or so. This borrowing disguised the fundamental structural imbalance in our national accounts. No government, however intent on making the pips of the rich squeak, has been able to raise in taxation more than 37 per cent of our gross domestic product. It is as though one of Adam Smith’s invisible hands has constructed a lead ceiling over the amount of income governments can lift off us taxpayers.
But no such ceiling operates on government expenditure. The most profligate of administrations spend up to half of all the income we create to finance what appears to have been a never-ending extension of public projects. The severity of the current slump magnifies many times over this fundamental faultline. But it is in no way its cause. If the economic recession was reversed this evening the huge imbalance between what governments raise and what they wish to spend would remain.
From the first signs of economic collapse the government has minimised its impact on its balance sheet. The Pre-Budget Report put the amount the government would need to borrow at £78 billion. But since then revenue has collapsed and expenditure is coming in way ahead of the government’s prediction. The unemployment level predicted for the end of 2009 was surpassed in February, meaning a much higher unemployment benefit bill has arrived ten months ahead of schedule. Clearly no one, including the government, has much idea yet of the true magnitude of borrowing. The last guestimate put it at £360-380 billion over the next two years when, at that stage, the government has stopped making any projections. While we clinically talk of public debt we are euphemistically speaking of trying to grab part of the income belonging to future generations to spend on ourselves.
Being on this debt merry-go-round is bad enough. But we are not the only country embarking on such giddy economic policies. The House of Commons Library has calculated for me what the G8 governments will attempt to borrow over the next two years. The sums are of gobsmacking proportions: a debt total of $2,245 billion this year, rising to $2,521 billion in 2010. The sheer size of these figures expresses our vulnerability. In contrast, in 1940, we had allies in the Commonwealth, particularly Canada, who gave us huge sums and, like America, lent us further monies so as to balance our war budget. Now our allies are part of the hunt for likely lenders.
If we comfort ourselves that there is that kind of money somewhere out there to be lent, we should be distressed that there will be, to put it mildly, a degree of competition between the possible destinations for that available cash.
It is at this point that the politics of recession takes over from those which operated during the sunny days of economic growth, rising government revenues and an ever open door to the world’s money lenders. At some stage the government will wake up to the awful realisation that borrowing on its projected scale might just be a rather difficult operation. And at this point the particular weakness of the UK’s position will become only too apparent.
By far and away the biggest government borrower will be the US. But that country is still protected by its reserve currency status. Likewise, the second largest borrower, Japan, goes into the money markets with very significant reserves. Britain, in third place in terms of the actual sums it needs to borrow, but easily the largest borrower in terms of sums being sought as measured against GDP, will face stiff and growing competition. That competition for funds is likely to become treacherous if, as a country, we have our credit rating revised downwards, which is now a distinct possibility before the summer is out.
The government appears to hope that it will gain enough cover by repeating ad nauseam that it is Keynesian common sense to borrow during the downturn and pay back when the economy is on a more even keel. Whether it really believes this is anyone’s guess. But its bluff might be called, and here will be a test not only for the current administration, but also for the opposition, whose consistent poll lead suggests it may form the next government.
The 30 per cent fall in sterling over the past year is cheerfully presented as opening up huge new export opportunities. While these opportunities seem somewhat delayed in registering in the balance of payments, its inflationary stimulus is already all too apparent. Despite the ever-present predictions of deflation, three of the four official price measurements are now on an upward path. The first signs of difficulty in raising any of the new walloping tranches of debt will not only result in long-term interest rates rising, no matter what the Bank of England gets up to in printing money, but will push sterling into yet another nosedive. Rising long-term interest rates and a collapse in sterling will place a firm grip around the government’s throat.
The government not only has a moral duty now to cut public expenditure, but may be forced to do so by its inability to borrow on the scale necessary. The price demanded for a continual and adequate supply of credit will be to begin now — and not after the next election — the Herculean task of bringing government spending nearer to what it can raise in taxes. This lead ceiling on tax levels should make any government cautious in thinking it can tax itself out of these debt levels. It might be worth trading in the 45 per cent tax rates, which the IFS believes will pull in little new revenue, for allowing pension contributions at the standard rate of tax only, with perhaps £5 billion being added annually to the revenue stream. But tax rises can only play a modest role in closing the enormous gap in the national accounts.
Again, it’s worth going for a cash ceiling on all public expenditure programmes. The drive must then be to ensure that falling real budgets result in increased output. This goal will not be easy to achieve and it will require a serious budget devolution so that entrepreneurial skills that are within the public system operate to full effect. But there will be no escaping the need to take out whole programmes if there is any prospect of bringing expenditure down merely towards tax revenue levels in a time-span necessary to continue attracting scarce credit.
The annual £180-190 billion gap will take some filling. Trident’s replacement comes in at between £15-£20 million. ID cards still have a £5 billion price tag. Freezing the health budget in cash terms could save something like £7.5 billion a year. Postponing the school leaving age and ceasing to overreach ourselves in sending 50 per cent of pupils to university, many of whom never complete their first year, would only bring in modest sums.
I raise these programmes as examples of the kinds of cuts that will be required to bring the national accounts towards balance. I am not suggesting that this is the programme, or that this list is adequate. But the threat to the country’s solvency is now so serious that both opposition and government need to use next week’s Budget on what needs to be done this year to begin rebuilding the country’s solvency.
This article first appeared in the print edition of The Spectator magazine, dated April 18, 2009