21 November 2017

Why is the Treasury so gloomy? The public finances are in rude health


I know these are unfashionable things to say, but the British economy is in much ruder health than many commentators admit, and we all owe a debt of thanks to George Osborne. The excellent public sector finance figures published today are a dramatic demonstration of these truths.

What a pleasant surprise for the chancellor Philip Hammond on the eve of the Budget.

The great financial crisis; the deficit, the great lode star of economic policy for nearly a decade; living beyond our means. Remember them? Well, they are sorted. Ancient history. Job done. In the year to March 2017 public sector net borrowing was £45.7bn or 2.3 per cent of GDP. That is down massively from £152.5bn, or 9.9 per cent of GDP in the worst year of 2010.

If anything, even that number is an exaggeration. It has been revised steadily down in the past few months by £6bn, from an initial £52bn. The Office for Budget Responsibility – which the Treasury relies upon – had originally forecast a deficit of that level too, and so, as usual, has been far too gloomy.

In my opinion, judging by the trajectory of the deficit in the past few months, the picture continues to improve and my guess is we are on course for a deficit of circa £42bn in 2017/18, or 2 per cent of GDP this financial year. Incidentally, the OBR is forecasting a deficit of £58.3bn for this year. That looks too pessimistic. Let’s see who is right.

The critical point about a deficit of less than 3 per cent to GDP is it is roughly in line with the underlying growth rate of the economy. That means, relative to the size of the economy, it is stable. To draw an analogy, it is like having a mortgage which may have risen in size in cash terms, but only in line with the value of your house. So your loan to value ratio hasn’t budged.

Ideally, you want your mortgage to be gradually paid off. But the fact it is stable is very far from a disaster.

Furthermore, half of the deficit run up since March – about £19.2bn – is actually made up of capital spending. Arguably, we should worry less about capital spending. It only costs the Government about 2 per cent to borrow. If it is investing in an asset which makes, say, a 7 per cent return (such as a new road), it can actually make sense to borrow. This is the equivalent of adding to your mortgage to dig a basement or build an extension. It can be a good thing.

What about the absolute level of debt? Well, two economists called Carmen Reinhart and Kenneth Rogoff have long advocated that countries with national debt levels of more than 90 per cent of GDP tip into crisis. Other economists have said this rule is far too strict. But let’s assume it is correct.

Britain’s top-line national debt to GDP is £1.8 trillion, or 87.2 per cent of GDP. That looks scary. But on closer inspection, a big chunk of this is offset by assets held by the Bank of England and the residual stakes the Treasury owns in banks like RBS. Strip those out and our debt to GDP is tolerable 79.6 per cent.

That is more than Germany but substantially lower than France, the United States, Japan and China. It really isn’t anything to worry about.

Whichever way you look at it, the performance of the British public sector finances continues to surprise positively. It is another example, like the earnings data, of how economics commentators are simply, in their very nature, too gloomy. What, I wonder could be their motive? Are they all secret Corbyn supporters? Or howling Remainers determined to do the country down?

The implications for public policy of the robust public finances are huge and nearly all good. Gone are the days where the Treasury should be squeezing spending and raising daft taxes here and there. We now have the room to take a strategic view about the future size and role of the state, without panicking about short term cash flow issues.

It means we can set tax rates to maximise growth and productivity in the medium term; we can afford to borrow to invest; and we can fix the problems which have built up in the recent past, such as the criminal 6.1 per cent interest rate on student loans, and the punitive and distorted levels of stamp duty. We can even afford an unfairly expensive bill to leave the European Union. Sadly, there is no evidence the Treasury itself sees things that way.

George Trefgarne is founder of Boscobel & Partners, a communications firm