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Reform today launches its report on the public finances.  The hole we are in and how to get out of it can be found at www.reform.co.uk

The report shows that a fiscal stimulus package in the Chancellor’s Pre-Budget Report would prolong the recession and damage the economy.

The public finances

The report finds that: “The UK economy has become obese. The country has been bingeing on debt, and over-consuming without working off the excess. The result is an overweight economy with unproductive, clogged arteries.”

The UK is entering recession in a vulnerable state.  Public and household debts are huge; the UK’s structural budget deficit is the 4th highest in the OECD; its trade deficit is growing; and high public spending programmes are predicated on out-of-date forecasts of GDP growth.

The crisis in the financial sector means that this recession could be the worst since the War. The IFS estimates that the UK’s structural deficit will deteriorate to 3.6 per cent of GDP in 2008-09. Including the Government’s long-term spending commitments on pensions and education, even without any fiscal stimulus, the UK faces tax increases of 6.6 per cent of GDP, or £100 billion per year – equivalent to £4,000 for every family.

The wrong options

A fiscal boost is not only likely to see poor results in increased economic activity; it would be damaging in sending the wrong signals. The impact on consumption would be small and transient and likely to be offset by the loss of confidence. Just because it is favoured by the economic and business establishment does not make it right.

Crisis cuts in public spending are also a bad solution. They would increase inefficiencies, by prompting the loss of experienced and capable staff. They are also self-defeating. As the experience of the mid-1990s showed, electorates react to perceived under-funding of the public sector by supporting higher spending later on.

The right options

In order to move beyond the obese economy, Britain has to consume less and work more. Households need a sense of direction towards a higher saving, lower tax economy. The short term objective is the same as the long term path to economic growth – to increase productivity. This should be the theme of the Pre-Budget Report and of Budget 2009, and the focus should be on three key areas.

1)Public sector reform. In his Pre-Budget Report, the Chancellor should announce that his Budget will set out a new Comprehensive Spending Review which would undertake the programme of reform that the Government did not introduce in the good times.

2)Private sector productivity. A recovery requires a sustained transfer of resources and investment into the private sector. Supply-side reform, the promotion of industrial competition and deregulation in key areas are crucial to stimulate growth.

3)Personal productivity. Individuals will be vital to an economic revival. To create a mobile economy and reduce wasted talent in the recession, individuals need to be empowered to take control of their own lives, spend more of their own money and invest in their skills and careers.

The sooner the long term problems that caused the obese economy are addressed, the sooner the economy will start growing again. At the heart of this has to be a change of culture towards a fitter and healthier economy: a better ratio of income to consumption; a better balance between savings and debt; and a healthier mix between the public and private sectors, and between industries.