Belfast Telegraph

We must consider long-term issues in handling deficit

Economy Watch

By Dr Esmond Birnie of the NI economic policy centre

The winds of change are definitely blowing through UK economic policy-making. In the March 2017 Budget the Chancellor Philip Hammond had already indicated that he was taking a more relaxed view as to how long it might take to re-balance the UK budget deficit.

The internal debate within the government on issues such as tuition fees and the public sector pay cap implies that containing public spending is no longer regarded as sacrosanct.

The Institute for Fiscal Studies (IFS) has suggested that a plausible option for the Chancellor would be to draw a line under further austerity and hold the deficit at its current level of just under 3% of GDP.

If the Chancellor did that it would allow him about £35bn of flexibility to increase spending, reverse planned cuts or prevent tax rises.

The General Election probably suggests that such a policy would be politically expedient but would it also be economically wise? Perhaps not.

It is true that we cannot be precise as to the level at which government debt or spending is "too high". Some recent attempts by economists to work out the level at which a high debt/GDP ratio begins to actually reduce economic growth have been somewhat discredited. That said, the current UK government debt/GDP ratio of nearly 90% is high by peacetime standards.

What is critical is maintaining the confidence of the international investors who buy up so much of the debt.

If that confidence is reduced then those investors will demand a premium to buy UK government bonds. In any case, as inflation rises and when interest rates start to go up again, it will cost a lot more to service the debt.

Another consideration is that we now have a budget deficit of about 3% even though the UK economy is already close to full capacity. How much scope would there be to increase the deficit if there was a recession?

Philip Hammond's predecessor George Osborne sometimes jibbed at the fiscal record of Labour saying that they had "failed to fix the roof when the sun was shining".

A Conservative could be about to do the same.

There is also a very long run consideration - the economic impact of longevity and hence an ageing population.

The likelihood is that demand for state-funded health and social care and for state pensions will continue to grow in the next decades.

Unless we make some fiscal adjustments now or are prepared for some rather radical adjustments in policy, the implications for both the budget deficit and the government debt/GDP ratio could be profound and perhaps alarming (the IFS has also made some projections about this).

Of course, government debt is not the only form of debt in the economy. As we all know, UK households are heavily indebted and consumer debts are close to the levels last seen just before the 2008-9 recession.

Whilst I believe the level of state debt does pose a challenge to the long run health of the UK economy it may be consumer indebtedness which provokes the next recession - could borrowing in the car market play the role that sub-prime mortgages played in 2007?

Finally, what of the Northern Ireland angle on the "end of austerity" and especially what of the impact of the recent package agreed by the Conservatives and DUP?

It is important to note that an extra £450m of public spending per annum over two years is a drop in the ocean compared to total UK public spending of about £800bn annually.

Post-2010 austerity was never as marked as some predicted it would be and the NI Executive departments experienced a smaller real terms funding reduction than almost all of the Whitehall departments.

Public sector employment in Northern Ireland is now about 10% lower than its peak level at the start of this decade - UK public sector employment is 15% lower.

A little noticed aspect of the Conservative-DUP deal is that, for good or bad, it appears to underwrite current (EU) levels of subsidy support for farming through to 2022.

If the deal is implemented, and it is worth remembering the economic/fiscal aspects of the previous Stormont House and Fresh Start agreements were not implemented in full, then the emphasis on providing funding to invest (whether in roads or fundamental reform of health service structures) is very commendable.

I am one of those economists/economic historians who have argued that the previous ready availability of public spending in Northern Ireland actually had some unintended and harmful consequences.

As was noted in the Soviet-era planned economies of Eastern Europe "soft budget constraints" sometimes cause waste and inefficiency.

The renewable heat incentive (RHI) affair is a cautionary example. It would not be helpful for the long run competitiveness and growth of our economy if Northern Ireland politicians were to adopt the economics of Oliver Twist by repeatedly asking London for more.

Belfast Telegraph