The deficit: the unspoken truth

The ritual coda to the British party conference season is not the moment when the last party leader speaks, but when the International Monetary Fund, holding its annual get-together in the still summery streets of Washington, awards its marks for the health of the United Kingdom’s economy. In the past few years, Christine Lagarde excoriated George Osborne for the dangers of his austerity programme. This time, her team praised the UK for consigning the effects of the financial crisis to the past, and reckoned that it would be the fastest-growing large economy in the developed world this year, outstripped only by the United States in 2015.

The criticism of the past was too harsh; this pronouncement is too generous. It ignores the twin uncertainties facing the UK now: how the deficit is to be closed, and the impact of higher interest rates when those come. It also makes too light of the other intractable problems: the housing crisis and the failure of wages to rise faster than inflation (a problem shared with other leading developed economies, which Prospect has focused extensively on this year). But the IMF is not alone in glancing over these issues. Leaving aside Ed Miliband’s failure to mention the deficit in what was rightly called one of the worst political speeches of modern times, the Conservative and Labour conferences failed to answer the question of how the deficit is to be closed. The Liberal Democrats did—by proposing to raise taxes on businesses and households—but not in a way that explained why growth would not suffer.

Take the Conservatives first. The Chancellor has set himself the target of eliminating the budget deficit—which in 2013-14 stood at £107.7bn, or 6.6 per cent of GDP—by 2018-19. He includes in his target both current spending and infrastructure, and says that will mean cuts of £25bn. The independent Institute for Fiscal Studies (IFS) reckons he will need cuts (or tax rises) of £37.6bn over the first three years of the next parliament.

In his most controversial proposal, Osborne said the party would freeze some benefit payments for two years. Why he thought this good politics remains opaque; while being “tough on welfare” clearly has public support, it will affect millions of people including many working poor, while raising just £3.2bn. As was widely noted, the funding for the £7.2bn of tax cuts proposed by David Cameron remains unclear.

Ed Balls, Shadow Chancellor, has set himself easier targets, aiming to balance only day-to-day spending of the government (on public sector pay and pensions, public services and the like) by 2020. The IFS reckons he might have to make £28bn less of cuts over that period than would Osborne over his shorter period, and he would have more room to spend on infrastructure. However, Balls has not explained how he would meet even his more modest deficit reduction targets; his proposed cap on child benefit would save only £400m, and Labour’s proposed “mansion tax” on properties worth more than £2m is already earmarked to cover more spending on the National Health Service.

Does it matter? The main reason for trying to shrink the deficit is that the country’s money would be better spent on public services and infrastructure than on paying interest; and markets can get rattled that countries with levels of debt-to-GDP not much higher than the UK’s can fail to meet their interest payments. Osborne has put a lot of weight on that argument, but so far it has looked exaggerated. Interest rates are so low at the moment that investors are offering the UK some loans at rates lower than inflation—effectively free money. But rates will rise at some point if other countries’ growth also takes off. Both arguments for cutting the deficit are strong. The differences between the parties are ideological ones, which will run through the 2015 election campaign: about how fast cuts should be, and how much spending on infrastructure might boost growth.

The Conservatives have been more honest about how much remains to be done, but that is a matter of degree. They have failed to make some of the key decisions that would unblock infrastructure developments, on nuclear energy, shale gas and airports. But the lack of directness about the scale of the cuts to come matters. Many voters think the pain is in the past and, with growth returning, that’s the end of the bad times. The realisation that there is much more to come will be a shock. That will make it hard to debate where, and how fast, the cuts should come, and in turn, where spending should best go.