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The IFS spells out the bad news

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Stephanie Flanders | 11:33 UK time, Wednesday, 28 January 2009

Anyone who wants to get to the bottom of the mess in the UK's public finances needs to read the latest Green Budget from the Institute for Fiscal Studies, out today.

This annual publication is usually for fiscal aficionados (try saying that quickly). But this year it has something for everyone - none of it good.

For the government, there's devastating clarity on the scale of the problem and how far Labour has come from the bright promises of 1997.

For the Conservatives, there's a warning that the economic options for an incoming Cameron administration would be even narrower than they think.

And for us lowly citizens, there's a road map to the future that makes for bleak reading indeed.

Typically we look to the IFS's Green Budget to find out how wrong it thinks the Treasury's budget forecasts are likely to be. There's some of that here too. The IFS economists reckon that borrowing will be more than £6bn higher this year and next than the Chancellor forecast in his November Pre-Budget Report.

Overall, they think the government is being around £20bn too optimistic in its forecasts for borrowing between now and 2013. That's not nothing. But, as the IFS admits, it's well within the margin of error for forecasts like these.

The average forecasting error for borrowing one year in advance is around £15bn; for forecasting three years ahead it is £30bn. The Green Budget's own forecasts for borrowing in 2007-8 were actually further off than the government's (oddly enough, both were too pessimistic).

More interesting than these short-term forecasts is a chastening bit of historical perspective.

Graph showing deficit under Tories and Labour

As this chart shows, the deficit under Labour has followed almost exactly the same path as it did under the Tories. Only this time, the final act is looking even worse.

After ten years of Labour we are entering this recession with a larger underlying deficit and higher net debt than we had going into the early 1990s recession. Britain had the second highest structural budget deficit in the G7 in 2007. And the Treasury now expects debt and borrowing to reach levels higher than those seen in any year under the Conservatives.

But the opposition shouldn't feel too smug. There's plenty in the IFS report to give George Osborne pause for thought. The IFS rejects criticism of the November temporary VAT cut: "Those dismissing it as a failure ignore the likelihood that things would have been even worse without it."

The IFS also gives the lie to the notion that the explosion in borrowing can be blamed on the November stimulus package.

ifs3point4.jpg

This wonderful chart shows the forecast for net public debt over the next few years - with, and without, the stimulus package. If you're finding it hard to spot the difference, that's the point.

At most the package accounts for only one-fifteenth of the rise in government debt by 2013-14. The looming hole in the public finances has very little to do with anything the Chancellor did to VAT.

The Conservatives have criticised the future tax rises announced in the PBR and insisted that tougher cuts in spending are the way forward. The IFS has now done them the service of showing them quite how tightly the government is squeezing spending already.

Thanks to the recession, spending will soar this year and next, but between 2010 and 2015 the budget is going to tighten by 2.6% of GDP. Of that, only 0.25% of GDP is accounted for by higher taxes.

Finally, the IFS brings the news that we taxpayers will be paying for the credit crunch for a generation. It reckons that debt will not fall back to the government's old ceiling of 40% of GDP until 2031.

The good news is that the Treasury isn't expecting that debt to cost us very much. If interest rates stay low, debt servicing as a share of GDP will be lower than in the mid-90s or early 80s. The bad news is that if interest rates go back up to more normal levels, debt will once again be on an ultimately explosive path.

On top of all that, there's a bleak assessment of the UK's potential growth rate over the next few years. But that's probably enough bad news for a single blog.

If you're looking for light relief, I recommend you take a look at the "four main goals for its management of the public finances" which Labour set itself in 1997, reprinted on page 10 of the IFS report. They're a hoot.

Comments

  • Comment number 1.

    Any comment upon the PBR assumption of a short sharp recession, or is that taken as a given?

    If the recession turns out to be long and drwan out what does this do to the figures?

  • Comment number 2.

    Regarding the VAT cut, it was aimed at trying to increase Christmas retail spending. If consumers are going to spend money at any time, they will do so at Christmas. It appears that although the number of retail transactions were up compared to Christmas 2007, the actual value of the sales and their profits was lower in 2008. Retailers' deep discounting was much in evidence.

    The important trend for measuring consumer spending will be retail sales January to June 2009. These figures will give us a more accurate indication of the British economy. Also, as the weak pound hits the buy prices for goods sourced from abroad, high street prices to British consumers are likely to increase during 2009.


    Regarding British government net debt and future liabilties, we all know that public sector spending will have to be cut in favour of increased government spending on bail-outs and stimulus packages for the private sector. The government cannot take the place of the private sector - it is the private sector which actually creates wealth and pays for the public sector.

    We cannot have a strong public sector without a strong private sector. Britain needs both at the same time, as each sector provides benefits for society as a whole.

    In the future, we are likely to see lower public sector spending, but at the same time higher taxes on private sector profits.
    Therefore, we will end up with a weaker public sector and a weaker private sector - the exact opposite of what we want.


  • Comment number 3.

    Hmm.
    So UK PLc is broke and no way out even under a regime change.

    No-one has a secure well paid job anymore.

    HMG (whatever flavour) will have to cut back, so jobs will go.

    Equals less taxpayers to pay increased dole.

    Skip straight to Economic Stagnation and HMG 'woe is me' navel gazing for years to come, unless solutions are found.

    What to do to stimulate economy?

    Don't try. Just offer industry massive incentives to get up and take them.

    Global Economic Stagnation needs a 'global infrastructure project' with 'global incentives'.

    Where does the money businesses need come from?

    From the 'global incentives', land, access to resources, tax breaks, etc.

    Once industry picks its feet up, everything else follows on naturally, albeit in time.

    Anyone with the political will out there to 'bite the bullet'?

  • Comment number 4.

    Jan Qvigstad,the Deputy Governor of the Bank of Norway,has one such rule of thumb (quoted by Dr John Llewellyn in "Lessons from a financial crisis")that trouble lies ahead if any of an economy`s key macro indicators-the public sector deficit(as a proportion of GDP);the current account deficit (as a proportion of GDP);and the inflation rate-exceeds a value of 4.
    It would be interesting to apply this rule of thumb to Britain for the last ten years.

  • Comment number 5.

    I'm afraid you're making a similar mistake to a couple of blogs back. Unless graphs identify tolerances or the margins of error thery're of little value.

    "Figure 3.4" is a clear case in point. After explaining how much uncertainty there is the projections you then - tongue in cheek, I suspect - draw some conclusions. The graph is meaningless (other than to introduce a bit of light relief into a mass of "boring" text").

    Moving on, your comment about increased interest rates leading to explosive growth of debt highlights the underlying reason why interest rates have been slashed and the pound is weak - UK plc is struggling to maintain the interest payments on its debt mountain.

    The whole of Chapter 2 makes for interesting reading, not just the four main goals. An unfolding tragedy with the thumbprints of one man all over it.

  • Comment number 6.

    Stephanie, I'm no economist, but I can tell you that the graph "Figure 3.4" is complete rubbish!

    The "actual" line fluctuates up and down so presumably this is how the system actually behaves. The prediction is that it then just goes straight. Clearly, what ever was used for this prediction is incapable of modelling the system in question.

    Furthermore, this prediction goes out 40 years ahead! Has any economic prediction ever predicted anything 40 years ahead with even remote accuracy?

  • Comment number 7.

    Thanks for pointing us towards the Labour goals on page 10, Stephanie, they were indeed hilarious. Were those goals formulated at the same time that Labour promised us "No more boom and bust"?

  • Comment number 8.

    Just a thought, but do the IFS figures for national debt include all the off-balance-sheet items (PFI and many others) that the government would like to pretend don't exist? How much of a difference does that make anyway?

  • Comment number 9.

    The 57% debt-to-GDP by 2011 forecast by Brown+Darling+Mandy seems a bit optimistic in light of the European Union's forecast for the UK of 72% by 2010.

    Perhaps something an investigative reporter could look into, rather than echo government edicts.

    And what could high debt mean for the man in the street, in addition to risk of hyperinflation?

    Well, if debt/GDP peaks at 75% and the government can borrow at 4%, 3% of GDP would be used to service the debt, or in case taxes account for 45% of GDP 1 out of every 16 pounds tax paid would be used to serve the debt. This would all balloon in case debt/GDP peaks at 90% with the government borrowing at 5% cost. Then 4.5% of GDP would be used to serve the debt and in case taxes amount to 45% of GDP, 1 out of 10 pounds tax would be used to service debt.

    And everyone should note that this only services the debt rather than also retire some of it and only relates to government debt, hence excludes private and company debt which now together accounts for 130% of GDP.

    From another country, all I can do is wish the UK good luck!

  • Comment number 10.

    Stephanie.

    Nice work by IFS as usual and you.

    This also shows up the lies and doublespeak of Crash Gordon BRuin's tax and waste Labour party...

    ...namely the vile slur that the Torys are do nothing when the accusers are doing nothing themselves, as shown by Figure 3.4.

    The aforesaid tax and waste has left us with no ammunition to use against this bad recession/depression/slump.

  • Comment number 11.

    As with all other mainstream economists the debate doesn't extend to why we have an economic system prone to boom and bust.

    Previous modes of production tended to have downturns only as a result of externalties, e.g. poor harvets, wars, etc.
    The capitalist system has downturns built into it.

    Capitalists only produce if they expect to make a profit.
    All the job losses, house reposessions, etc are a consquence of the mode of production - a set of human relations, not an externality like the weather which humanity is powerless to affect.

    We don't have to live with a system that produces only for profit and disregards need.

  • Comment number 12.

    Ho ho ho! What's a "structural" budget deficit? Is that the deficit after massaging and fudge factors?

    How come all these figures don't reflect all that money pumped into the banking system?? Ah yes of course - those are "one-off" costs and therefore don't reflect a "structural" deficit.

    It really is a bit rich to claim it is news that the STRUCTURAL deficit is the same with and without the one-off short term stimulus - which would be excluded from the definition of a structural deficit anyway!

    It's also fair to point out that for the first two years of Labour's term in office (i.e. the bit where their graph is improving) they were following Conservative spending plans!

  • Comment number 13.

    Dear Stephanie

    I have read hundreds of Blogs, both public and your fellow correspondants, and dozzens have asked the question
    "Where has all the money gone"?
    Not a single relpy on this subject, so, can you, along with your fellow Bloggers give us a reply.PLEASE? -----Andrew, ----Mark, ----Nick---- Robert---- hAVE YOUR SAY.?
    "wHERE HAS ALL THE MONEY GONE"?

  • Comment number 14.

    Kudos for highlighting the mirth-inducing economic goals of the Labour 1997 Manifesto.

    A quick google will reveal the complete text. I've got to tell you there are some absolute belters.

    A referendum on proportional representation for one.

    I was taken in too.

    Blockbuster will actually rent you Leni Reifenstahl's 'Triumph of The Will'. It should be broadcast just before the next Labour party conference so that we can all better understand just how we've been manipulated.

  • Comment number 15.

    Dear Stephanie, Have youread the IMF Rort Btians out put will slow by 2;8% this year 2009 if this the case its well out side that of the treasury, and economically a disaster.

  • Comment number 16.

    A bit more in depth and analytical than Mr. Pestons take on the Economy, nice. I can't skim read and pick up the gist of it. I will have to actually read it.

    Not as popular as Pestonspicks yet but give it time and we may get a decent bunch of the more hardcore and interesting posters and we can leave the Peston blog for the more ill informed.

  • Comment number 17.

    As I understand the IFS press release they were basing their estimations of the Governments previous predictions of an upturn in the third quarter of this year. (This is now quite improbable.)

    It is interesting that they appear to be predicting a very long squeeze over several parliaments.

    Clearly this is politically unacceptable and will not occur - something will give. Cutting ones cloth etc. will occur, no matter who is in power.

    My guess is that, baring a war which would necessitate rapid economic expansion, the defence budget will give along with infra-structure replacement. I do not see that cutting the social budgets will be at all popular and thus will be resisted by all parties.

    The IFS appear to have discounted wage cuts in the Civil Service, but these are possible along with pay freezes for the private sector, if the 1930's is used as an archetype.

    All in all they are describing the 'D' word (and I don't mean that there will be a 'd-notice issued to prevent us talking about it!) The recession they describe will be uncomfortable and I guess that the discomfort will be shared - certainly by the Bankers.

    I still feel that the recovery of the economy and public finances will come sooner than they predict, by at least a couple of years, say by 2015 (as I have previously said.) I can't see it being politically acceptable for any parties to not generate a proper recovery until 2020 or later.

    I think the projections that they produce demonstrate that in highly volatile circumstances such projections have huge probabilities of error - but what again I do not see is a professional estimation of these errors, but I suppose it might be there if I was to pay for the full report, but there seems to be only one small section "2.5 Uncertainty and the Treasury's fiscal forecasts" on the matter.

    I'd give what I've seen a B for effort.

  • Comment number 18.

    Simple question, why is it called a 'Green Budget' -the Green Parry produce something called that every year.
    As this is more utter spin the report is not worth the cyberspace it is blogged on, just the same self justifying claptrap as normal

  • Comment number 19.

    Is it worth noting that the IFS report is produced 'in collaboration with Morgan Stanley'.

    Morgan Stanley is the successor organisation of JP Morgan the premier us banking company in 1931. Recently Morgan Stanley changed its status from investment bank to bank holding company and sold 21% of itself to Mitsubishi UFJ Financial Group, Japan's largest bank.

    The head of Morgan Stanley is apparently not going to Davos!

    Reuters is reporting: "Our three signposts for the next growth cycle/bull market ... will give us an advance warning, maybe as early as later this year," Morgan Stanley says.

    This seems to be at odds with the IFS report on the British situation so perhaps the world will pull the UK out of recession!

  • Comment number 20.

    #13 "wHERE HAS ALL THE MONEY GONE"?

    .…to support the inefficient economy; to buy useless goods and overpriced houses; to maintain artificially high life styles of many; to support quangos and other unproductive organizations; and last but not the lest - for bonuses or gains to thousands of ponzy managers and other financial speculators. The list is not exclusive.

  • Comment number 21.

    The Report comments of

    'eight years of drift'

    'newly-discovered structural weakness'
    etc

    do sound suspiciously like an absence of Government strategy and an absence of Government awareness and controls.

    Short term Event Reaction rather than Planned Direction appears to be the house-style.

    If the Government has an economic strategy, then someone should be able to articulate it in not more than a couple of sentences.

    And then the supporting sub-strategies and the tactics to be used should bear scrutiny in how they support the stated strategic aims.

    Perhaps a suitable question from the Interviewers might be constructed around the above.

    A good report, thanks for the analysis.

  • Comment number 22.

    No. 13. freecornwall wrote:

    "Where has all the money gone?"

    (i) Equities were sold and the money held in short term money market deposits (client accounts) by brokers, waiting for the bottom of the market to appear before reinvestment;
    and
    (ii) Equities were sold and the money invested in US Treasury bonds, British Gilts, German Bunds, etc
    (iii) Assets were sold to pay off loans which originated from countries with trade surpluses whose population saved rather than spent, such as Japan, China, Middle East oil producing nations.
    So, money was sent from US and UK back to the countries named above;
    and
    (iv) Assets were sold and the money invested in precious metals, such as gold;
    and
    (v) Debtors went bankrupt and their liabilities were written off, causing bad debts for their creditors;
    and
    (vi) Partly, the money never really existed in the first place. Assets trade for prices far in excess of their intrinsic value. For instance, if 100 people want to buy a desirable second hand object, such as a painting or a house, they bid against each other until the final price is set by the two richest people. Therefore, the two richest set the price for the whole market. For example, the first 95 people can afford to pay no more than £100 for the object. The next 3 bidders can afford £150, and the final bidder pays £201 for it. The whole market thinks the value is £201 for any similar asset, when the real price is only around £100. When people are selling in distress, the price then drops very quickly to say £75 or less;
    and
    (vii) Other undisclosed safe havens.
    For example, many people bought contemporary art for high prices in the boom years. These art works are sitting in a box in a warehouse somewhere. They have not yet been sold.
    Also, rich people bought million pound yachts and are busy sailing round the world on them as we speak.

    That should give you a general idea.

  • Comment number 23.

    So am I to understand that the report actually contains some serious reservations, but then they have bundled them up with some sugar to make the pill much easier to swallow whilst at the same time massaging and thrashing this governments ego?

    A good political document if it is.

    What I'd like to know, especially considering the graph in 3.4, what happens if some of the variables that these assumptions are based on move slightly in line with the market expectations?

    I also think that much of these figures actually ignore the elephant in the room...public sector pensions and their effects over the same timescale.

  • Comment number 24.

    I am a sorry but the game so far has been one of catch up by pundits and ever downward projections. Therefore all projections until proven otherwise are just that projections.

  • Comment number 25.

    #13
    Money exists in two forms
    as a tangible entity like a coin or a bank note. When money exists as credit someone must have the negative of of it commonly known as debt; 97% of the money supply is in the form of debt created by private commercial banks and interest baring the other REAL money 3% hasn't a negative its printed by the government, interest free (Also earning seinorage ) which reduces our public debt.
    So this idea that the government is printing tons of the stuff is B******S If an elected government takes back control of the money supply IE genuine nationalisation
    the banks could remain privately run businesses after all they have the infrasructure and the experience !
    So where has all the money gone "Gone to graveyards every one"

  • Comment number 26.

    Free Cornwall

    'where has all the money gone?'

    Not where it should have, that's for sure!

  • Comment number 27.

    Ten years in charge of our nation's finances in one way or another, and the only way GB has reduced any of our debt is by selling our gold reserves at their lowest price and paid off our war debt to the US!

    As you say, four main goals (which would be called a financial mission statement in many quarters) is hilarious!

    As am ex teacher I'd grade it with an 'A' as a fictional work full imagination,creativity fantasy and vision which has enough elements of reality as to hoodwink an entire nation!

    Bloomin' marvellous!

    A definite inclusion in the study list for 'A' level English!

    Brilliant!

  • Comment number 28.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 29.

    The whole depression has been running so long now I am worried that I am starting to lose interest..

    There isn't anything left to say... well... nothing that hasn't been said over and over again.

    As for the predictions and forecasts...I cannot see any reason to have any belief or faith in any of them.

    It's bad...it will get much worse...point...ends

    Sticking somebodies finger-in-the-air number on it doesn't mean a thing...if they were good at forecasting they'd have forecast this mess.... they didn't... but I know plenty of very ordinary UK people who were doing so.

    They're saying now :" It's bad ...it will get much worse and stay bad for longer than the experts reckon"...draw a graph if you want .... cheerio

  • Comment number 30.

    Some comments on report comments:

    "The looming squeeze on public spending means that, even once the economy is back at trend in 2014–15, the Treasury plans imply that over the following two years only 21% of the ‘proceeds of growth’ will be consumed by the public sector. This is down from 44% under Labour to date and 29% under the previous Conservative governments."

    So, no change to past and current state busting polices and PPP/PFI initiatives then, if the6y can find the funding.

    "From 1996–97 to 2007–08, the Treasury estimates that real national income rose by £12,700 per family – of which families are paying £5,600 more in tax, leaving them with £7,100 more income after tax. Between 2007–08 and 2013–14, the Treasury expects real national income to rise by £4,900 per family – of which £1,900 will be taken in tax, leaving an increase in after tax income of £3,000."

    Averages mean nothing given the vast divide in earning power.

    Note to Stephanie: When you interviewed Flynn and Mackintosh on IQ a while back, you should have interviewed Lynn, Rushton and Jensen too. Countries run on human capital. We have been diluting ours, that's the problem. You need to look into it.

    Too many journalists treat what they are fed as truth. These industries use academics and journalists to give their own agendas credibility. Getting at the critical variables which drive socio-economic change requires years of gruelling work against strong currents of politically correct ignorance. See the ETS summary February 2007, what's going on in our schools/streets, and get Lynn and Vanhanen on to Newsnight.

  • Comment number 31.

    So what happens when a very large percentage of the population suddenly declare bankrupcy?

    Say 3-4% of the working population?

  • Comment number 32.

    11. duvinrouge wrote:

    "Previous modes of production tended to have downturns only as a result of externalties, e.g. poor harvets, wars, etc.
    The capitalist system has downturns built into it"

    The reason is simple: capitalism has upturns in it. There is therefore the risk of going down as well. Pre-capitalism (feudalism) had no upturns. Take a look at a chart of economic growth in England from medieval times onwards (they do exist somewhere - I saw one once). Basically, there was no sustained economic growth until industrialisation in the 18th century. The much vaunted Industrial Revolution actually resulted in growth of about 1% pa, which we'd now regard as being a bit anaemic in normal times.

    I don't think downturns are "built in" to capitalism. It's just pretty hard to judge the macro supply-demand balance accurately enough to prevent the need to jam the brakes on every now and again. The current downturn has different causes, I accept. Normally, though, it's the inability to manage demand accurately enough that pushes us into downturns.

    Incidentally, the reason why capitalism appears not to satisfy needs is that, on the whole, it's already fulfilled that function a long time ago. Much of what is spent in the developed world goes on "wants" not "needs". We can fulfil our needs from a relatively small proportion of our income. That's actually one of the great success stories of capitalism married to democracy. Contrast that with feudalism, where workers struggled to cover their needs while allocating virtually 100% of their resources (typically their labour power) to production to fulfil those needs. Contrast it to communism, where needs were decided by the Party, who then produced statisitcs to show those needs/targets had been met. Note that little was actually produced, other than statistics and propaganda.

    To paraphrase Churchill, capitalism is the worst form of economic organisation ever invented, except for all the others.

 

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