Extraordinary times call for extraordinary measures. Alasdair 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 misconceived.
On the big picture, Gordon Brown is right and David Cameron 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 – £78 billion in this tax year, £118 billion 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 £20 billion 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 $500 billion, or even $700 billion, 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 overindebted consumers to spend more is wrong-headed. 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. The government should instead have done far more to limit job losses, repossessions and bankruptcies and to 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 would have been much better.
Likewise, the £1.3 billion 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 £1.8 billion 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 wish.
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 £3 billion 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 taxes are likely to have to rise by more in the next parliament than the 0.5% increase in national-insurance contributions and the introduction of a new 45% tax band on incomes above £150,000 announced now.
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 – witness the rescue of the US banking giant Citigroup over the weekend – further action will no doubt be needed soon. The government may need to inject further capital into Britain’s ailing banks – and more outright nationalisations may even be necessary. A further fiscal stimulus is also likely to be needed in next year’s budget. It’s a pity it wasn’t announced this week.