UK Will Miss Deficit Targets, But Blaming Europe Is 'Nonsense'
The government's deficit reduction targets are likely to be missed as growth undershoots official projections. But analysts said pinning the blame on the eurozone sovereign debt crisis is disingenuous, as structural problems in the UK economy become clear.
Reducing the government's deficit is contingent on having at least modest growth to bolster tax receipts, and continued weakness in the economy will undoubtedly have an effect on attempts to cut the deficit. The Office for Budget Responsibility (OBR) had forecast a rebound taking GDP growth above 2% by 2012. The consensus among forecasters and economists is that that is now implausible.
The Bank of England trimmed its 2011 and 2012 forecasts to below 1% on Wednesday and warned that there were significant downside risks emerging from the continued paralysis in the eurozone.
"If the growth numbers continue to run below the OBR's assessment in the medium term, which I and I think most other people believe is the case, then clearly the government is going to find it very difficult to meet its medium term objectives," Peter Dixon, economist at Commerzbank, said.
At Tullet Prebon, global head of research Tim Morgan, was more direct: "We're looking for cuts of £135bn from the deficit, £20bn from public spending cuts and 115bn from higher tax. Some of that comes from raising tax rates, such as VAT, but a big chunk of it seems to come from growth well in excess of 2.5%, and as far as I'm concerned that's not within the bounds of realism."
Missing the deficit targets would not be devastating, Dixon said, and rating agencies are unlikely to be overly punitive - maintaing the UK's AAA-rating has been routinely cited as a reason for sticking to 'Plan A'. However, he added: "I think we should all be a bit more grown up about the credit rating and say, we don't really care what the rating agencies say, let's concentrate on what really matters, make sure we get the growth which in turn will help reduce the size of the deficit."
That growth seems hard to come by, and the go-to excuse has been the ongoing deadlock in the eurozone, which rumbles on without any credible solution.
"The Bank of England has pointed continually to exogenous factors as why inflation has been above target and growth has undershot," Dixon said. "Whilst these are all kind of true, the bank itself is ignoring the bigger truth, which is that the private sector in the UK is deleveraging, and in those circumstances you can expect only a certain amount of growth. This is Japan in the 1990s. So whilst the bank is right to point to the risks to the downside emanating from external factors, I think to a large degree, the slowdown that we are seeing, or the growth undershoot, comes from problems at home."
Japan's asset price bubble in the 1980s led to a situation where land values soared and credit became cheap. Consumption rocketed. In the end, the bubble burst, the stock market crashed, banks needed to be nationalised and companies faced a long and painful period of 'deleveraging' - reducing their credit stock by consolidating and cutting back investments.
Japan's corporate raiders have never really recovered, and the country as a whole suffered from the "Ushinawareta Jūnen" - lost decade - of slow growth and socioeconomic stagnation throughout the 1990s that it is still struggling to escape.
The situation in the UK is not exactly comparable, but survey after survey shows that companies are battening down the hatches, reducing their debt stock and holding cash. When asked if Britain faces the possibility of a lost decade, Dixon said: "I'm increasingly of the view that it is, not just in the UK but in many parts of the industrialised world."
But while leverage in the private sector is likely to fall, the public sector, despite the rhetoric, is piling on more debt.
Labour has been quick to point out that the Treasury's monthly aggregate of independent forecasts showed that the consensus view is that the government will borrow nearly £110bn more over this parliament than Osborne had planned.
Research from Tullet Prebon released on Wednesday looked at the real state of government borrowing and debt, and concluded that while the government's cutbacks will reduce the deficit, they are not going to reduce the national debt. The UK has only been saved from the fate of the highly indebted peripheral eurozone economies is the devaluation of the sterling and the government's rhetorical commitment to cuts, Morgan said.
"You have to find spending cuts. One of the things that I find frustrating about the current political situation is that government is talking tough on spending, whereas in fact it's doing very little. And the opposition isn't proposing doing anything too different from that. There's a kind of phoney war going on."
Public spending has increased from £451bn in 1999-2000 to £688bn in 2010-2011, Tullet Prebon's analysis showed. By comparison, the coalition's commitment to shave spending by £20bn over five years is very modest.
"There's a sort of consensus that says we can't do much about spending, which in my view is nonsense," Morgan said. "Labour - it's in their DNA to increase spending. The coalition haven't really had the courage to take on the issue of where all that extra spending was. In real terms we've gone from spending £450bn to £690bn, that's a 50% increase? Where has that money gone? Are we getting any value for money for that massively increased spending? I'm arguing that we're not. I think to a certain extent this government's gone native. The Whitehall belief is that we can't spend much less."
Looking for easy excuses is not helping, he added. The truth is probably harder to swallow. The problems in the UK - unemployment and growth - predate the euro crisis, and exports have not been meaningfully hit.
"Blaming the whole thing on the eurozone is nonsense," Morgan said. In fact, he added, the last few years of growth have been founded on "smoke and mirrors". The construction, retail and financial services industries were driven by a private sector borrowing boom - hundreds of billions of pounds of private credit pouring into consumption - while health, education and public administration benefited from the government spending. Those industries combined represent 70% of the economy, which "cannot grow," according to Morgan.
The government spending increase of the 2000s can be reversed, Morgan said, by reforming procurement, which has been responsible for the majority of the spending increase.
The proceeds, he advised, should be poured into tax cuts for small businesses - which are typically the engine for job creation - and for average consumers, who, hit by flat wages and rising inflation, are keeping their wallets shut.
"We tried low interest rates, we tried printing money, we tried borrowing and spending - none of that has worked," he said. "The only thing we haven't tried is cutting taxes on working people and small businesses."