The deal between the Tories and Lib Dems was the best result the country could have hoped for. But the good news ends there. John Stepek and David Stevenson report.
First, the good news. Gordon Brown has gone. After a fraught election result and days of wrangling, David Cameron has finally elbowed his way into Number 10.
Now for the bad news. Cameron has been left a nasty legacy: a country tied up in legislation and on the verge of bankruptcy. When Gordon Brown became Chancellor in 1997, Britain had a deficit of £6bn.
It’s now £163bn. In 1997, the British tax code was less than 5,000 pages long. It’s now nearly 12,000 pages long – the longest in the world, in fact. Two things have kept Britain out of the market’s crosshairs up until now. First, the fact that countries such as Greece have looked even more vulnerable than Britain; and second, the hope that a new government would find a way to cut spending fast.
But now – for the time being at least – Greece has the European Central Bank standing behind it. That leaves Britain looking like less of a safe haven and more of a potential target. With a fresh government finally in place, it’ll be expected to act, fast. We are no longer eligible for benefit of the doubt. And that means the next few years will be tough for all of us.
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The ‘recovery’ won’t last
We’ve all heard so much about Britain’s deficit (its annual overspend) and national debt (the debt pile it’s already racked up) that it’s easy to become blasé about it. But we can’t afford to, because now our economy is facing what Jonathan Loynes of Capital Economics describes as “the Great Squeeze”.
Britain’s budget deficit this year will be the biggest in the European Union, bar none, at 12% of GDP, reckons the European Commission. Our 6.8% primary deficit (that is, the shortfall before interest costs) is bigger than Greece’s. On top of that, our national debt is already at 60% of GDP. That’s not yet as bad as many other countries, but it’s the rate at which we’re adding to it that’s the problem.
Moreover, this figure doesn’t include the many off-balance-sheet nasties, such as public-sector pension funding and healthcare costs – not to mention private finance initiative (PFI) projects. It also assumes that there are no hidden surprises waiting for the Tories when they look through the books upon taking over – after all, the Labour party refused to have a spending review before the election, for fear of spooking the voters. So it’s only now that we’ll get some genuine clarity on the true state of the nation.
One thing is for sure. Our current rate of spending is unsustainable. Now that the election is over, the markets won’t let Britain keep running up its national overdraft without at least having some idea of how the borrowings will be capped. None of the parties came clean about the sorts of tax hikes and spending cuts needed prior to 6 May.
Now, reckons Robert Chote of the Institute for Fiscal Studies, the spending cuts will have to be the deepest seen since at least the 1970s. Like it or not, says Loynes, “the next five years will be defined by an extremely painful fiscal squeeze”. That in turn can’t be good for economic growth. We might be out of recession for now – GDP grew by at least 0.2% in the first quarter of 2010 – but there’s no guarantee that we won’t be pushed back into one by the grim medicine we’ll have to take.
There is a bright spot in the UK economy: manufacturing. It’s the sector that’s suffered the most under 13 years of Labour rule, but now, thanks in part to the collapse in sterling, it’s one of the few areas of the economy that is doing well. However, while that’s good, as Loynes points out, “industry is not big enough to drive a solid recovery in the overall economy” by itself.
The services sector and the consumer are much more important to the UK economy. And here the news is pretty unremittingly bad: even now, at a time when disposable income has been propped up by ultra-low interest rates and lowish mortgage payments, consumers look pretty fragile. High-street sales fell by 2.3% year-on-year in April.
Simon Wolfson of high-street giant Next (who should know) has warned that he expects consumer spending to slow down during 2010. “Whether growth turns negative again is almost impossible to predict. But the one thing we can say with certainty is that whatever action is taken to curtail the deficit it’s likely to put the brakes on any consumer recovery.”
Why the gloomy outlook? Well, on the one hand, higher taxes seem inevitable. And whichever way you cut it, higher taxes are not good for growth. If you charge consumers more VAT, they can’t afford to buy as much. If you push up the national insurance rate, it costs more for employers to hire people. And if you drive up taxes on corporations and individuals in general, you give them all the more reason to either move country, produce less, or devote a larger chunk of their resources to finding ways – legal or illegal – of getting around the higher charges. And then there’s the spending cuts. These are crucial. Soon the latest 53,000 rise in unemployment for the three months to March will seem like a drop in the ocean.
Public-sector employment will plunge
Forget this notion that savings can be had purely by trimming ‘waste’. Yes, the last government did plenty of things inefficiently, and there is doubtless a lot of slack in the system. But what’s really needed is a sober look at what the state can and cannot afford to do on behalf of its citizens. And like it or not, that will involve job cuts.
The parties’ pre-election manifestos will need to be torn up – a process that has already started – in favour of some grim realism. If the ‘ring-fencing’ of sacred cows suggested by the Conservatives, for example, was to be stuck to, then we’d be looking at unfeasibly severe cuts in other public services – the equivalent of the Ministry of Defence no longer employing an army, for example.
So the pain will have to be spread around. How bad could it get? The job situation is already pretty dire in Britain, with around two and a half million people out of work. But Vicky Redwood of Capital Economics thinks unemployment could rise as high as three million next year. The research group reckons – based on the Labour government’s figures, which could well be too optimistic – that over the course of the next five years, public spending needs to fall by about 3% a year. About a quarter of public spending goes on pay – £158bn in the 2008/2009 tax year. Cutting 15% of that bill (over the next five years) would mean saving about £24bn. To do so, as well as pay freezes, around 730,000 public-sector jobs would have to be axed.
It sounds severe, but that would still only take the total number of public-sector workers down to where it was in 1997, when Labour came into power. It’s been done before – between 1991 and 1997, says Redwood, “public-sector employment fell by 800,000”. The trouble is, this time around, the private sector won’t be in much condition to pick up the slack. In fact, Redwood also expects to see “renewed job-cutting” in the private sector as economic growth disappoints.
Bad news for house prices
Higher unemployment is bad news for house prices. When people lose their jobs, they run into trouble paying their mortgages. That means higher repossessions and deteriorating bad debts for banks. That’s one reason why banks don’t want to lend to many people to buy houses right now. As Cliff D’Arcy puts it on Lovemoney.com, compared to the boom years, “mortgage lending today is as dead as a dodo”. In 2006 mortgage lending grew by £112bn, then by £109bn in 2007. But during 2008, the increase was just £39bn. In 2009, it was lower, at £9bn. And in 2010 so far, it’s just £5bn. Yet in April, Nationwide reported that prices rose 10% year on year, while Halifax reckoned it was 6.6%. How? The answer is pretty straightforward. The number of sellers has dived, leaving what buyers there are chasing too few houses.
However, this can’t last. On the one hand, there are only so many financial refugees from troubled economies such as Greece to bolster the upper end of the London market. Meanwhile mortgages can’t, and won’t, get any cheaper. As the market continues to defrost, with more sellers putting their houses on the market, prices will come under pressure.
As Melissa Kidd at Lombard Street Research points out, if you look at the Nationwide quarter-on-quarter growth rate, rather than the annual growth, it’s been slowing since September 2009. With the exception of last month, surveys from the Royal Institution of Chartered Surveyors show that the sales-to-stock ratio is continuing to fall. So the number of houses on the market is rising while sales aren’t keeping up. With more forced sales likely, and fewer willing and able buyers around, we’d expect to see further sharp price falls in the coming years.
The emergence of a Tory-Lib coalition is the best news the country could have hoped for post-election. But as Clegg and Cameron surely know, the fact that they managed to make a deal is the only good news there is.