UK economy is stuffed – but not as badly as Greece

UK economy is stuffed – but not as badly as Greece

You can hardly blame George Osborne for over-egging the point. Gordon Brown was still trying to blame the Tories for all the ills of the world 13 years after they were swept from power, as if his own mismanagement of the economy in the meantime might not have had a little something to do with it.

By Jeremy Warner, Assistant Editor
Published: 10:22PM BST 17 May 2010

So it seems reasonable enough that still less than a week into office, Mr Osborne should use the opportunity of his first Treasury press conference to blame the last lot for all the pain he's about to inflict. It's what incoming governments do.

But it's rare indeed that an incoming governments gets such manna from the last lot.

"Dear chief secretary, I am afraid to have to tell you the money has run out, yours, Liam." This single-line letter from the outgoing Chief Secretary, Liam Byrne, to his successor at the Treasury, David Laws, was apparently meant as a joke, but it serves equally well as New Labour's final epitaph. Had Mr Byrne said: "we've spent the lot, and frankly, you're stuffed", he could scarcely have been more blunt about the true horror of Labour's legacy.

Things are much worse than you think, Mr Osborne said on Monday in an attempt to soften us up for the blows to come. In an interview, he said: "By the end, the previous government had become completely irresponsible and has left this country with terrible public finances, worse as a proportion of our economy than Greece."

Mr Osborne is hardly the first to say it, and strictly speaking he is right on both counts. I've written myself at length about the pork barrel spending that took place in the run up to the election, with ministers showering money on the regions as if it was confetti. It is also true that the UK has one of the biggest Budget deficits in Europe. But Britain is not yet Greece, and the new Chancellor should take care not to frighten the markets into believing it is.

The public finances are possibly in worse shape than the previous Government was letting on, and obviously there are a whole range of public liabilities that should properly be brought back on balance sheet. Public Finance Initiative liabilities alone have rocketed from £60.5bn in 2000 to £206.8bn (nearly 15 per cent of GDP).

But I would be astonished if Mr Brown had actually lied, a la Greque, about the true state of the books. Much of the smoke and mirrors that took place under Labour were almost childishly transparent. The real problem lies rather in the use of overly optimistic assumptions about growth and tax receipts. These may be unrealistic, but Britain is hardly alone in assuming a possibly unrealistic rebound to above trend growth.

There are a number of reasons why comparisons with Greece are ill-founded and possibly quite dangerous. Greece, too, it will be recalled showed no lack of enthusiasm for tackling the deficit. It was only after the Papandreou government announced its first austerity programme that the real damage to confidence occurred. This was primarily because the markets fast realised that the scale of the consolidation was so extreme that it was likely to condemn the country to years of economic contraction, thus making the medium term debt burden worse, not better. Greece would thus be incapable of repaying its debts without help.

This doesn't have to be the case in Britain, which in any case has a much larger and more robust tax base. What's more, the UK mercifully still has control of its own currency and interest rates, so can counter the fiscal medicine with accommodative monetary policy. The eurozone's reluctance to apply any kind of inflationary counterweight condemns much of the Club Med to extreme deflationary contraction over the years ahead.

Mr Osborne's task is similar to that of applying chemotherapy; in seeking to kill off the cancer of the deficit he must be careful not to lose the confidence of markets and end up killing off the patient too. It's a balancing act between too little and too much. On Monday, he said a little too much.

Even so, the new Chancellor's first day at school was on the whole an encouraging one. The establishment of an Office for Budget Responsibility under Professor Sir Alan Budd is an important innovation which promises to restore credibility, destroyed under Mr Brown, in the Government's handling of the public finances.

Sir Alan is right to view his task as more important than the establishment of the Monetary Policy Committee by the incoming Labour Government in 1997. Inflation was yesterday's enemy by the time Labour came to power. To me, it seems unlikely the Government's judgments on interest rates would have been significantly different from the Bank of England's.

Indeed, the idea that economic policy was somehow safe in the Bank of England's hands lulled everyone into a false sense of security, thereby allowing Mr Brown a degree of leeway on tax and spend he might not otherwise have enjoyed. Rather than pump-priming the feel-good factor with interest rate therapy, the Government did it instead with debt and public spending.

Mr Brown cynically manipulated the "golden rule" to the point of laughable irrelevance. By the end, Britain was running the sort of deficit you would normally expect from a recession, not an economy in the midst of a consumer boom.

Mr Brown was not just judge and jury, he was prosecution and defence too. By calibrating the Government's tax and spending plans against genuinely independent forecasts for growth and the economic cycle, the OBR should do for management of the public finances what the Bank of England did for monetary policy.

Sir Alan was a key player at the birth of independent inflation targeting. He rightly regards his latest task as an altogether bigger challenge. The scale of it is laid bare in the International Monetary Fund's latest "Fiscal Monitor". Across advanced economies there needs to be an adjustment amounting to 8.75pc of GDP on average to primary Budget balances to get overall debt down to pre-crisis levels of around 60pc.

More work still needs to be done to deal with projected increases of 4 to 5pc of GDP in health and pensions spending over the next 20 years. Those countries that fail to achieve fiscal sustainability will see their growth potential permanently and seriously impaired.

But Mr Osborne shouldn't be too downhearted. Things could be worse. The ruinous deflation that Britain might be facing now if it were in the euro hardly bears thinking about. On this level at least, comparisons with Greece are justified. Whatever Mr Byrne says, we are not as badly stuffed as they are.

http://www.telegraph.co.uk/finance/economics/7734494/UK-economy-is-stuffed-but-not-as-badly-as-Greece.html