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Extraordinary times call for extraordinary measures. Alistair Darling’s statement was a pre-budget report
only in name; in reality, it was an emergency budget crafted by Gordon
Brown. It was big and bold, but it should have been bigger and bolder.
Worse, the main plank of the government’s plan to support the economy –
a cut in VAT to stimulate consumption – is misplaced.

the big picture, Gordon Brown is right and David Cameron is wrong: a
fiscal stimulus is urgently needed to prop up the economy as demand
slumps. Faced with the sharpest downturn since the 1930s, interest-rate
cuts are not enough. While a further increase in government borrowing
is risky, doing nothing – and risking an even longer and deeper
recession – would be reckless.

The forecasts for government
borrowing are huge – £78bn in this tax year, £118bn in the next – but
national debt will still peak at only 57% of GDP, comfortably below the
level deemed prudent by EU rules. It is not a tragedy if public debt
rises even higher in the short term. So the Conservatives’ critique is
wide of the mark. The real problem with the government’s stimulus
package is that it is too small and poorly targeted.

A stimulus
of £20bn between now and April 2010 is not trifling, but it amounts to
only 1% of GDP. It will do little to fill the gap left by the collapse
in private consumption and investment, not least since some of the
stimulus will be saved. In comparison, president-elect Obama’s team are
considering a fiscal boost of $500bn, or even $700bn, over two years –
which is equivalent to 1.75%-2.5% of GDP in each year. A bigger
stimulus would not only provide a bigger boost to the economy directly,
it could also help restore confidence, by signalling to consumers and
companies that the government is serious about supporting the economy.

The focus of the emergency budget is also misdirected. Encouraging debt-ridden consumers
to spend more is wrongheaded. For a start, it may not work: since
retailers’ hefty discounts are doing little to tempt shoppers to spend,
a cut in VAT of 2.5% is unlikely to either. But even if it does work,
encouraging consumers to go on yet another spending spree is unwise
when they need to start saving more. It would be far better had the
government done more to limit job losses, repossessions and
bankruptcies and invest in areas, such as infrastructure, that bring
long-term benefits to society.

For sure, the measures to help
small businesses are welcome. A combination of tax cuts and loan
guarantees will help. But a large share of the assistance consists of
merely deferring a planned rise in corporation tax. A temporary cut in
corporation tax for small businesses would have provided a lifeline for
them and their employees.

Likewise, the £1.3bn package to protect
jobs is too small. More jobs could be saved if the government
introduced a temporary cut in employers’ National Insurance
contributions. And while the £1.8bn housing package is better than
nothing, three months’ grace for those struggling with their mortgages
will bring little relief. The government should also provide funds for
housing associations or local authorities to buy up property that banks
wish to repossess, allowing homeowners to remain as tenants if they

Above all, the focus of the stimulus package should have
been a big increase in investment in infrastructure and other public
works, along the lines proposed by president-elect Obama. Instead, the
government merely brought forward £3bn in capital spending, a drop in
the ocean. It should be doing much more: bringing forward and
increasing spending on social housing, upping and accelerating
investment in Britain’s crumbling infrastructure, especially transport,
and offering bigger subsidies for energy-efficiency measures, such as
loft insulation.

Longer term, the government’s growth and
deficit forecasts look optimistic. It seems unlikely that the economy
will start growing again as early as the second half of next year. The
recovery is also likely to be slower than the government predicts,
since consumers will be struggling with the burden of their excessive
debts for many years. So looking forward, the tax rises in the next
parliament are likely to be bigger than the 0.5% increase in National
Insurance contributions and the introduction of a new 45% tax band on
incomes above £150,000 announced.

The measures announced in the
pre-budget report are unlikely to be the last word. As the crisis
continues to take violent and unpredictable new turns every other week,
with the US banking giant Citigroup
forced to seek a bail-out over the weekend, further action will no
doubt be needed soon. The government may need to inject further capital
into Britain’s banks – and outright nationalisation may even be
necessary. A further fiscal stimulus is also likely to be needed in
next year’s budget. It’s a pity Darling didn’t announce it yesterday.

Posted 25 Nov 2008 in Published articles

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