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A Brown hole not a black one Samuel Brittan: Financial Times 11/04/03 Economic commentators will never lack for employment so long as popular comment treats the British government as a corner shop run on a cashflow basis. Before, during and after the Budget we were regaled with horror stories about "black holes": Gordon Brown is having to borrow an estimated £27bn in the 2003-04 financial year. This is reminiscent of the equally illiterate hysteria that prevailed when Norman Lamont had to borrow £46bn in the recession of the early 1990s. Then it was Labour that sneered whereas today it is being sneered at. On some assumptions the chancellor is indeed borrowing too much; but on others he is not reckoning to borrow enough. Mr Brown's borrowing represents 2½ per cent of the gross domestic product. This includes investment as well as current spending and is based on actual expectations, and not cyclically adjusted numbers in which I have lost confidence. If the chancellor's Red Book is read backwards from the last page, as it should be, it soon emerges that there are built-in forces that should reduce future borrowing. The tax to GDP ratio is expected to rise by two percentage points between 2002-03 and 2005-06, as a result both of the national insurance increases announced last year and of "fiscal drag" - the automatic increase in tax receipts as incomes rise. Many sceptical City analysts nevertheless believe that the chancellor will have to come back to raise more tax before many moons have elapsed. There are three principal supply side issues on which the Treasury may be too optimistic. It could have overestimated the amount of spare capacity in the economy; it could have overestimated trend growth; and the tax yield of GDP may be less than anticipated. Some of the revenue gains in recent years reflected the overspill from the stock exchange and property booms; and it is anyone's guess how much to adjust revenue forecasts for a more bearish outlook. The chancellor's Red Book suggests that the British economy is now 1½ percentage points below the level of capacity utilisation compatible with stable inflation. The Organisation for Economic Co-operation and Development puts this negative gap at only ½ per cent and the Bank of England at even less. This is a difficult call to make when we have a divided economy with much surplus capacity in the manufacturing and export sectors but still signs of strain in the housing and labour markets. On the growth side, the question is how much weight to give to the meagre annual rise in output per hour in the last few years compared to the Treasury expectation of a bounceback to over 2.3 per cent. Clearly, if the Treasury is overoptimistic on all three fronts there is trouble ahead, even if the world economy snaps back to normal growth rates as it expects. There would then be a political choice to be made between increasing tax rates yet again or modifying public spending plans. All these, however, are basically supply side factors. More serious are the worries on the demand side. The latter have been labelled by Andrew Smithers, the economic consultant, "Professor Wynne Godley's doom machine" after the Cambridge economist who has most forcefully expressed them. In essence it is simple. Household debt in both the US and UK is excessive. The US private sector as a whole, corporate plus household, will attempt to get back into its normal position of balance or slight surplus. The contractionary effect of such a swing can only be offset by a US budget deficit even greater than now envisaged, rising perhaps to 9 or 10 per cent of GDP by 2007. This would be accompanied by a rise in the US current balance of payments deficit to similar proportions and is said to be improbable. Thus the danger is slump. This pessimism may be overdone. The authors in question may tend to underestimate the potency of monetary policy to offset swings in the economy. They may also underrate the budget and balance of payments deficits which the US may run if the euro economy and Japan continue to stagnate. But if there is anything at all in their fears, then we are in for a harsh world economic climate in which the last thing that Mr Brown should do is to attempt to cut the budget deficit further. Even if one is sceptical of the ability of such deficits on their own to sustain demand, they may be an important adjunct to central bank efforts to boost the money supply when nominal interest rates have reached their floor. As Ben Bernanke, the Federal Reserve governor, recently reminded us, money-financed budget deficits are practically equivalent to the dropping of money by helicopter. Crystal ball-gazing is a mug's game. Much more important is contingency planning and this is not helped by nonsense about black holes.
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