Ed Balls is in a sulk. The academic Keynesians have been routed. Even the International Monetary Fund has been shown to know about as much about the global economy as the average X-Factor contestant. Despite dire warnings that the coalition’s austerity programme would sink the UK into a recession to equal the 1930s, Britain is staging a stronger bounce back than just about anyone had expected. Chancellor George Osborne has already started to crow about that – understandably so, since so many people told him he was steering the economy onto the rocks.
“We held our nerve when many told us to abandon our plan,” he said on Monday. “And as a result, thanks to the efforts and sacrifices of the British people, Britain is turning a corner. Those in favour of a Plan B have lost the argument.”
Yet there is a cloud on the horizon – and one with a very dark lining. The markets were prepared to tolerate our huge deficit because Britain was still viewed as being in deep recession. Indeed, the debate was all about whether we should relax austerity and spend even more. But if the economy is growing, that debate is over.
There is no question the economy looks in better shape than it did just a few months ago. Revised GDP figures last month showed the British economy grew by 0.7% in the second quarter of the year. Some predict that growth could reach 1% for the third quarter.
Last week, rich-country think-tank the OECD sharply raised its forecast for Britain’s economic growth this year to 1.5%, from 0.8%. Retail sales were up 1.1% in the last month, and house prices are fizzing again. Both the services and manufacturing sectors are purring along, and jobs are being created in the private sector. It is not exactly an economic miracle – but it is a lot better than most people expected at the start of the year.
You can argue about how long it will last. And you can argue about whether it is the ‘wrong sort’ of growth – based as so often in the past on artificially low interest rates, too much debt, and soaring house prices. We will see. Britain has had the ‘wrong sort’ of growth for so long, it is probably too late to change tack now. And the people who argue for a ‘re-balancing’ of the economy presume to know what the right balance might be. For now, the chancellor will be pleased just to get any kind of growth the right side of a general election. And whatever the doubts about the nature of the expansion, it is clear that the modest cuts to government spending we have seen so far have not hurt it.
But that doesn’t mean we’re home and dry. Britain has been running a vast budget deficit for the last five years. In 2013 it will hit 7.1% of GDP, according to the OECD. Even with slightly faster growth, it will still be 6.5% of GDP in 2014. That is one of the highest levels in the developed world. France is on 4% this year. America is on 5.4%. Germany is very close to running a balanced budget. Even Greece and Spain are running lower deficits than we are – their deficits are 6.9% and 4.1% of GDP respectively.
The markets have been very tolerant of British debt – so far. Britain lost its triple-A rating, but it made very little difference to the government’s ability to sell gilts. As well as being supported by quantitative easing, most institutions that trade government debt bought into the theory that it does not make sense to cut deficits savagely in a recession. So they were willing to give Britain a free pass. It didn’t really matter if the deficit was huge. That was due to the state of the economy.
But what if economic growth accelerates to 2.5%-plus? What if it is growing faster than any other major European economy – an outcome that looks perfectly plausible for 2014? Suddenly that deficit looks less like a wise way of dealing with a recession, and more like hopelessly profligate spending from a government that has forgotten how to control its books. Gilts start to look less like a safe haven, and more like an accident waiting to happen.
Indeed, the cost of our debt is already rising. The cost of ten-year debt has risen from around 1.7% in April to 2.7% now. That is a significant jump. And what if it goes higher? We are already spending 3% of GDP servicing our national debt, more than we spend on defence. That interest bill will only rise.
So far, the government has done very little to bring the deficit down – far less than the Greeks, the Spanish, or even the French. It has relied on cheap rates and gradual growth slowly to bring it back to a sustainable level. The trick has worked so far. But now that the economy is growing at a decent clip, markets are likely to start demanding serious measures to cut spending or raise more in tax. If that doesn’t happen, they will head for the exits.
Unfortunately, there is no sign as yet that this coalition, or indeed the voters, are ready for a full-scale assault on public spending. Perhaps the Tories should conspire to lose the next election, and leave Ed Balls to do the job.