Unfinished business

Some said it was a re-run of the 1981 Budget. Others said the Chancellor had imported Clintonomics into Britain. But while it was a Budget of excellent beginnings, it was not in fact sufficiently austere to qualify for either title.

After last week's political row about the VAT change, it may come as a surprise that the Chancellor's overall measures were actually rather tame. A tax increase of pounds 10.5bn, or 1.5 per cent of national income, by 1995/96 certainly sounds draconian enough. But consider the following.

A year ago, the Treasury said the PSBR would drop to only pounds 6bn by 1996/97. Now it says that the PSBR in that year will be pounds 35bn, even after allowing for the tax increase of pounds 10.5bn. In other words, the underlying level of borrowing has risen from pounds 6bn to pounds 45bn, and only about one-quarter of this deterioration has been offset by tax rises.

Furthermore, it should be borne in mind that the Budget was only about the revenue side of the government accounts. To judge the overall toughness of budgetary policy, we must also take account of the public spending figures announced in the 1992 Autumn Statement. Although they were presented at the time as extremely Spartan, this was another myth. Partly because inflation has declined so fast, it now appears that the real level of government spending has increased by 6 per cent in 1992/93, and it should rise by a further 4 per cent next year.

This boost to government spending means that budgetary policy (measured by the change in the budget deficit adjusted for the economic cycle) will ease by around 1 per cent of national income in 1993/94. The tax increase of 1.5 per cent of national income in the following two fiscal years is only just large enough to offset this, leaving the budgetary stance tightening by a very modest 0.5 per cent of GDP over the next three years taken together.

The equivalent budgetary tightening in the four years of the Clinton fiscal proposal is about 2 per cent of national income, or four times as large - which, by chance is exactly the same amount by which Sir Geoffrey Howe increased the tax burden in 1981 alone.

Norman Lamont has therefore announced only part of the budgetary retrenchment that will probably be necessary before the next election. Perhaps the Treasury would have liked to have done more; certainly, there was nothing in the Chancellor's language last week that suggested he is anything other than alarmed by the prospects for government borrowing over the next few years.

But here was a doughty knight announcing that his crusade would begin in a couple of years' time, probably with an exploratory trip as far south as the English Channel, should the weather at the time appear clement. No wonder the trumpet call sounded a little thin.

None of this would matter if the Budget had been intended as the opening shot in a continuing war against excessive public borrowing. On the Treasury's present arithmetic, another dose of tax increases of about the same size as those announced last week will be needed over the next three years in order to stabilise the ratio of outstanding government debt to national income by the end of the present Parliament. But can this now happen?

Some in the Treasury are optimistic that a second dose of the fiscal medicine, perhaps on the spending side, will be politically feasible once the economy is recognized to be recovering. But it is just as possible that the decision to pre-announce a medium-term plan for tax increases could make it harder to add further unpalatable measures as the election approaches, especially since the PSBR should by then be falling. Why, some Tory MPs may ask, is it necessary to rip up the medium-term plan, which was difficult enough to sell in the first place, just when things are beginning to improve? And, as we were reminded by the argy-bargy over heating bills last week, it only takes 11 maverick backbenchers to wreck an entire Budget.

It may seem to many that all this discussion of fiscal tightening is a trifle out of place in an economy that is still struggling to emerge from such a catastrophic recession. But the failure to announce a decisive budgetary tightening over the medium term could soon leave some government officials arguing for a tightening in monetary policy. Recent economic data have undoubtedly been very encouraging, and not just for the past month or two. Following the latest revisions to GDP figures, we now find that non-oil output actually stopped declining at the end of 1991, since when activity has been essentially flat.

It is likely, following a further reshuffling of the beans on the Central Statistical Office's abacus, that the trough in the recession will be dated in the fourth quarter of 1991, almost exactly when the infamous 'green shoots' were first spotted by the Chancellor (see graph). Furthermore, while most commentators have been talking about the 'surprising' strength of retail sales since the turn of the year, the latest monthly returns have done nothing more than maintain the trend which started in April 1992, immediately after the general election.

Ever since then, abstracting from monthly 'blips', the trend for retail sales has been growing at an annualised rate of about 3 per cent. All this suggests that the 'big picture' for the economy involved a bottoming-out process, prior even to sterling's departure from the ERM, and on past cyclical form it would be surprising if the recovery failed to pick up steam over the remainder of this year.

If policymakers agree with this conclusion (and in private they are much more confident about the strength and durability of the recovery than they are yet willing to admit in public), then the analysis of UK economic policy must enter a new chapter. We may be emerging from the period in which the dread of a slump has dominated all thinking. Once the Government becomes a little more confident that the recovery is indeed under way, its focus may shift towards ensuring that the upswing does not peak too soon, thus ruining the Prime Minister's election planning.

In other words, thoughts of a policy tightening may come back on to some people's agenda much sooner than I would like. What is more, there will undoubtedly be voices in favour of raising base rates to more 'normal' levels if the consumer continues to spend. There have been persistent reports that the Treasury was opposed to the cut in base rates to 6 per cent in late January. If so, then some hawks in Treasury Chambers may already be looking to rescind what they see as 'one cut too far'.

That, however, would be a huge mistake. With other European interest rates now starting to tumble, any hint of an increase in UK base rates, especially, in the context of a recovering economy, would undoubtedly push sterling considerably higher against the mark and other EC currencies - and that, in the longer term, would not be compatible with a move towards equilibrium on the balance of payments.

If it turns out that domestic policy does need to be tightened again this year, the Chancellor must turn his back on a base rate rise, and return to the unfinished business he started last Tuesday.