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Cuts and trust

The banking crisis that unfolded during Labour Party conference a year ago now almost seems like a bad dream. As delegates debated the crisis, we were not to know that worse was to come. The basic functions of the economy were about to face a severe threat and it was only bold leadership which pulled us back from the brink. Now we are confronted by challenges on tax and spending. Britain faces a recession, even though there is more optimism now than when Alistair Darling delivered his Budget in April. The danger is that Labour addresses the cuts issue on Tory ground rather than its own.

The increases in public sector debt are sobering indeed, with borrowing expected to be £175 billion this year and similar next year. However, before we panic, we need to appreciate why borrowing has risen. Put simply, deficits in the financial, business and household sectors are being moved onto the Government’s balance sheet so those sectors can recover. As economic activity picks up, so will tax revenues. The Government could have raised taxes and cut spending to compensate for lower tax revenues as the recession kicked in. While this would have kept Government debt down, it could well have tipped us into a 1930s-style depression.

Unfortunately for this country, we appear to have a further problem with our debt. This was outlined in the Budget and highlighted by the Institute for Fiscal Studies in a report published last month. Part of the national debt is regarded as structural, which means it is not linked to the cycle.

The Chancellor’s estimate of the permanent structural deficit rose by 6.4 per cent of national income (£90 billion a year). Tax revenues seen during the boom years in the City will not all return and the Treasury estimate of the economy’s productive potential has been revised downwards.

To some extent, the debt bubble provided us with higher than normal tax revenues, which the Labour Government spent on new schools and hospitals, for example. In effect, some of our tax receipts were debt financed. Now those revenues are unlikely to return and so tax income and spending are further apart.

If spending is not reduced or taxes are not raised, the debt level will increase. That’s because we have to pay interest, no matter low and assuming we have low inflation. Hence the talk about spending cuts, although few politicians and commentators are also talking about tax rises.

In fact, it is not clear why belt-tightening should begin next year, as the Treasury assumes, and why the deficit must be paid off by 2017-18. Budgets must have credibility, of course. But controlled high deficits can be sustained for many years if resources are properly targeted. The problem facing us immediately is that, despite recent optimism, a durable economic recovery is not yet guaranteed. Levels of bank lending to businesses have dropped year on year, which is not normal – even in a recession. Meanwhile, unemployment continues to rise. We may find we actually need to increase borrowing in order to stimulate investment. Nevertheless, Labour needs to demonstrate that the nation’s finances will be under control, which will mean spending cuts at some point.

The debate within the Government about whether to talk about cuts was finally resolved when the Prime Minister used the word in his speech to the TUC, pledging to protect frontline services. Leaked Treasury documents and Cabinet discussions point to preparation by Whitehall for some tough spending rounds.

The Tories are not being responsible in this debate. They are calling for spending cuts now, but the economy and banking system are too fragile. Their performance over the past couple of years of financial crisis has been abysmal and their economic team has yet to convince people that it really knows its stuff.

The political risk Labour supporters face is to find ourselves making our case on Tory terms. Spending cuts were associated with Conservatives. We spent more than a decade hammering that point home. If spending cuts are the main point of politics, voters may note that the Tories are rather keen on the idea. The debate needs to be about the kind of future society we want, because Tory cuts would take us backwards and risk bringing about the broken Britain they talk so much about.

That debate can still be won. For the left, the issue is how government ensures people have a meaningful stake in society and, following RH Tawney’s prescription, more freedom in their lives. At times, that will mean cutting waste or focusing on key priorities, such as unemployment.

Neither should we forget that the country is now using the new schools and hospitals built over the past few years thanks to this Labour Government. New hospital equipment will not simply vanish. In many ways, even with the problems we currently face, Britain is now a better country in which to live in than it was when Labour took office in 1997.

We need to work fast to apply our values to government spending choices. That does not mean simply arguing about the spending programmes on which we can save money. We need to be more robust and say which programmes should not survive. As we debate the next election manifesto, that has to be our task. The challenge is harder still. It will be a poor manifesto that just contains lists of spending programmes saved and others cut. It will be a grim read if we simply swallow the conventional wisdom about the economy and the public finances, threatening a recovery before it has taken root. We have more hope and confidence than that.

Tribune 2 October 2009, 02/10/2009

Not an easy task given uncertainties, especially if energy and commodity prices do fall later in the year. Ultimately, radical economic reform required.
Central banks are struggling to head off general inflation while dealing with price shocks that will be negative for growth. They waited too long, which has made their tasks more difficult.
The Bank of England has raised interest rates, but that does not mean it has been most effectively managing inflation risks.
The Bank should signal it will act if higher prices look likely to translate to higher inflation rate.
The IMF's Fiscal Monitor is actually quite radical.
Spare a thought for finance ministers, and the opposition counterparts who aspire to replace them. The conventional wisdom was that they should at least make an attempt to follow fiscal rules. Now, there are no rules.
My letter in the Financial Times on the need for a framework for economic policy decision-making.
Responding to Brian Griffiths' article in The Article on the risks of inflation.