FT/Wolf: The government takes a huge gamble on investor confidence

The government takes a huge gamble on investor confidence By Martin Wolf

Financial Times Published: November 24 2008 17:47 | Last updated: November 24 2008

17:58

Stuff happens. Stuff has certainly happened to both the UK economy and the government?s fiscal position. What Alistair Darling delivered on Monday was not a pre-Budget report, but a crisis budget. He scrapped the hallowed rules of his predecessor and boss, Gordon Brown. Profligacy has replaced prudence as the chancellor?s watchword.

The government is taking a huge gamble on its ability to sustain the confidence of investors in the UK. I believe it is right to do so. But nobody knows. The risk that these monstrous fiscal deficits ? with public sector net borrowing forecast at 8 per cent of gross domestic product in 2008-09, falling to 2.9 per cent only in 2013-14 ? will trigger a sterling crisis, a big sell-off of UK government debt, or both, is not small. The decision to raise the top rate of tax to 45 per cent, after two decades is symbolic. If 45 per cent today, why not

50 per cent tomorrow? Expectations are no longer anchored.

Certainly, this statement failed to admit either that the crisis has domestic roots or how far the past policies of this government explain the enormity of the fiscal position: the UK did not have to have a huge housing boom financed, in large part, by the wholesale financial markets; and the UK did not have to go into the downturn with big fiscal deficits.

Also serious, I believe, is the failure to admit that a fundamental structural change is now under way ? from soaring household borrowing, a booming housing market, a bloated financial sector and rapidly growing public spending, towards higher savings and current account surpluses. The economy has to become far better balanced in the years ahead. The UK has enjoyed the fat years. Now come the lean ones.

It is unclear from the chancellor?s speech that the government recognises the scale of the structural challenge, though the planned growth of current government spending, at 1.2 per cent a year, goes some way in the right direction.

It is evident that its forecasts are not worth the paper they are written on. Nobody?s now are. The Treasury forecasts recovery from the third quarter of next year, as lower commodity prices and interest rates and the fiscal boost start to work. The economy is expected to contract at between -¾ per cent and -1¼ next year and then to grow at

1½ -2 per cent in 2010. If so, this would be a mild recession. Anything is possible. But I do not believe it, given the scale of the shocks. The frightening possibility is that the chancellor is still understating the deficits ahead. Net borrowing for 2009-10 is now supposed to be 5.5 percentage points higher than forecast in the Budget. It could well end up much higher still.