Right back where we started

By Michael Burton | 01 April 2020

As if dealing with the coronavirus were not sufficiently challenging, the ever-cheerful number-crunchers have come out with some early statistics suggesting that the years of austerity have all been in vain: the public finances are back where they were in 2010.

Capital Economics, the macroeconomic research institute, estimates that the combined impact of the downturn in business and extra Government spending means borrowing – the deficit – would rise from 1.9% of GDP this year to 10.8% next. This is higher than the worst levels in 2009/10 following the financial crisis when the deficit ballooned to a peak of 10.2%. Total debt could hit 104% of GDP next year compared to forecasts by the Office for Budget Responsibility (OBR) of 77.4%.

In its March outlook before the chancellor’s announcement of support for businesses, the employed and the self-employed, the OBR forecast a rise in the deficit to 2.2% in 2024/5. This was a result of the ‘fiscal loosening’ in Rishi Sunak’s March Budget.

All this is dwarfed by the scale of spending and the collapse in economic activity due to the coronavirus.

Capital Economics said the Government’s measures alone could increase the deficit to 7.3% of GDP next year. Lower tax receipts could add another 3.5% taking the total to 10.8%.

The Institute for Fiscal Studies (IFS) is a little less gloomy in its forecasts, predicting a deficit of 8%.

Isabel Stockton, a research economist at the IFS, said: ‘It would not be surprising if [the Government’s] measures were to add around £120bn to borrowing, more than tripling the amount forecast just weeks ago and pushing borrowing up to £177bn or 8% of national income. This would be more than 2008/09, but some way below its peak of 10.2% of national income in the following year.

‘There is a substantial chance that borrowing will turn out considerably more than this if the economic hit is greater or a large fraction of private sector employers take advantage of the employment retention scheme.’

About 40% of that increase would result from new fiscal measures and the rest from the economic downturn, depressing revenues and adding to Government spending.

The IFS said: ‘A deficit of over £200bn in the coming financial year is well within the bounds of possibility.’

Morgan Stanley last week forecast that the UK economy could contract by 5% this year due to the impact of the pandemic, which would leave it more than 6% smaller than forecast in the Budget two weeks ago. Even this estimate is based on a ‘robust’ rebound in the second half of this year that assumes consumers go on a spending spree.

The total package of additional spending could cost more than £50bn, or 2.3% of GDP in 2020/21 – already more than the UK’s fiscal response to the financial crisis, when the total UK fiscal stimulus package was 0.6% of GDP in 2008/09 and 1.5% of GDP in 2009/10.

There is, however, a major difference compared to the aftermath of the financial crisis. Recovery then was slow. GDP was sluggish, dragging down tax revenues. Many economists argue that the Coalition’s austerity policies were too severe and perpetuated the downturn. Cuts in welfare and local government budgets hit poorest areas hardest.

This time, until the virus appeared, the economy was relatively strong and Mr Sunak’s March Budget injected Keynesian-style capital spending into the economy with the aim of ‘levelling out’ public investment to the poorer areas that had voted for Boris Johnson in the December election.

Mr Sunak’s recent announcements have reversed some of the welfare cuts planned since 2015, such as increasing the standard annual allowance in Universal Credit by £1,000 for one year and increasing housing benefit.

The hope is that when – or if – the virus subsides and the economy gets back to normal there will be a pent up burst of consumer spending that will feed into tax revenues. But, as the IFS’s Isabel Stockton said: ‘The changes in the public finance landscape that the outbreak has brought about will remain with us long after the immediate crisis has passed.’

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