FOR most of the past three years UK households have enjoyed encouraging news about the economy and their financial situation. Inflation is at near zero. The economy is growing. Real wages are rising. There are record numbers in work.
So why is it, six years on from the financial crisis, the government’s budget deficit has just delivered a shock upward jolt and remains stubbornly high?
Without a growing economy and productivity improvement resources are finite
If progress has been so good, why does “austerity” remain a potent political charge? And if we are set fair, as we have been constantly assured, for further growth ahead, why are key pointers indicating a slowdown? With interest rates still down at near-record lows – despite repeated predictions of rising rates – we should surely be doing better than a growth rate set next year to settle at 2.3 per cent – barely above its long term average.
Welcome to the world of paradox economics. Arguably the most glaring is the behaviour of the public finances. By any measure we should be seeing consistent progress in bringing down the budget deficit – the gap between government spending and tax revenues.
Income tax receipts in particular should be on a strong upward trend. Latest labour market figures from the Office for National Statistics show continued improvements, with another record UK employment rate at 73.5 per cent and 413,000 more people in work than last year.
At the same time, total pay grew by 2.9 per cent over the year and by 3.4 per cent in the private sector with retailers, services and construction seeing the largest growth in pay.
Last week brought a nasty surprise. The latest figures showed the budget deficit rose markedly in August due to a fall in income tax receipts. The public sector net borrowing excluding banks climbed to £12.1 billion in August, up from £10.7bn a year earlier and to the highest August figure since 2012.
Nor did the bad news stop there. A previously reported surplus of £1.3bn in July was revised to a shortfall of £606 million – slightly larger than the £427m shortfall in July 2014.
While the deficit is still down so far this financial year, Chancellor George Osborne’s deficit target for the current financial year looks rather harder to achieve. Global Insight economist Howard Archer predicts that if the pattern of the first five months of 2015-16 continues, the deficit would amount to £80.7bn, overshooting by some £11bn the downwardly revised target of £69.5bn set out in his July budget. And with some important pointers suggesting an economic slowdown is under way, there is the risk that tax receipts could disappoint further, pushing the achievement of a budget balance backwards yet again – just like the good old days of Gordon Brown.
The main cause of the August downturn was a 3.5 per cent fall in income tax receipts. This, suggests the ONS, may be the result of tax receipts in July-August being at a record high. But even after allowing for this, the rise in PAYE receipts flowing from pay growth and higher employment should surely be propelling a sustained rise in tax receipts – and further falls in the deficit.
This is not the only paradox. Far from personal borrowing falling back from the over-stretched levels that prevailed before the financial crisis, household budgets are set to be deeper in the red than ever. The Office for Budget Responsibility now expects household debt to grow significantly in the coming years – from 146 per cent of income currently to 170 per cent by 2020 – even higher than the pre-crisis peak.
Bearing in mind the bombardment of warnings on over-indebtedness and the need for households to row back on outstanding debt, it is astonishing that we are set to be more indebted than ever on our personal finances.
The danger here is that, if Bank of England governor Mark Carney’s predictions of a rise in interest rates “at the turn of the year” prove accurate (at last), many debt-stretched households could be badly hit. This in turn would put a question mark on assumptions over the strength of medium-term consumption growth.
But there is another contradiction – the continuing charge of public “austerity” which has dominated political debate before and since the election. The government stands accused of relentless further cuts in public spending. But the figures suggest otherwise. It is notable that central government expenditure did not fall in August, but rose 2.4 per cent year-on-year, and was double the overall increase of 1.2 per cent seen during April-August.
Both UK public sector current spending and total managed expenditure were forecast in the summer budget to rise by 1 per cent in 2015-16 over the previous year. And the Scottish Government budget for 2015-16 shows departmental expenditure limits up by 2.2 per cent.
Any politician can hold out the prospect of “an end to austerity” and scrapping of the welfare cap. But without a growing economy and productivity improvement resources are finite – particularly so when overall public debt now stands at £1.5 trillion and annual debt interest payments have hit £47bn.
The constraints are obvious. It is the job of government to operate within constraints. The business of priorities is centrally the business of politics.
What, finally, of economic performance overall? Only three months ago the Chancellor was still trilling on how the UK was outperforming the Eurozone and most of the G7 economies. But clouds are encroaching on this blue sky picture.
The September CBI industrial trends survey shows a net zero balance of firms reporting output growth in the three months to September – the first time there has not been a positive reading on this measure in two and a half years. Overall orders fell in September, primarily due a marked dip in export orders to a six-month low.
As a result, manufacturers’ output expectations for the next three months were at their lowest level since October 2013. Slower global growth in China and Europe will constrain the UK’s growth potential for the foreseeable future.
What should Osborne do in the approach to his spending review due on 25 November? Correct any continuing overshoot in budget deficit projections and work on measures to improve productivity performance. Paradox and contradiction come and go. But the discipline of budgets is forever. «