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After the fog...?

  • Stephanie Flanders
  • 28 Jan 09, 08:26 PM GMT

There used to be something symbolic about Davos - all those movers and shakers going to the mountains to talk about capitalism being on top. This year the more apt feature is the fog. No one knows where the world is going. But they're fairly sure it's in the opposite direction to the one before.

It's not just that economies have gone into reverse - spectacularly so in the case of the UK, if you share the pessimism of the IMF. There's also a more general sense - that the market capitalism they've promoted so long here at Davos is now seriously in retreat.

Even here, the call is for more regulation and more government to save the global market system from itself. But when the fog finally lifts, some here fear there won't be much of a global market system left. At least when it comes to international capital.

Speaker after speaker in the meeting halls talked today of preventing a costly retreat into protectionism. But where the financial system is concerned, we're already there. Nearly all governments are pressuring their banks to direct scarce lending to their home markets, with costly consequences for countries like the UK that depend on foreign loans. When things get tough, we've learned that even the most 'global' of commercial banks will skulk home to raid the coffers of national governments.

Persuading developing countries to open their economies to global capital flows has always been a hard sell - especially after the emerging market crises of the late 1990s. Now even some senior policy makers in the UK and US are wondering whether a global capital market can work.

In a few years time, Davos Man may make a comeback. But if it's globalisation he's talking about I suspect it will be globalisation minus finance.

The IFS spells out the bad news

  • Stephanie Flanders
  • 28 Jan 09, 11:33 AM GMT

Anyone who wants to get to the bottom of the mess in the UK's public finances needs to read the 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 拢6bn higher this year and next than the Chancellor forecast in his November .

Overall, they think the government is being around 拢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 拢15bn; for forecasting three years ahead it is 拢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.

Graph showing public debt over the next few years

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.

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