UK: Spend, Tax and Borrow (page 1 of 3)

The Chancellor Gordon Brown delivered his Pre-Budget Report (PBR) to Parliament. Along with the annual Budget in the spring, this is the opportunity to outline the government's latest economic and fiscal plans. Here we analyse why the upbeat Chancellor may be just too optimistic.

Overview

The UK Chancellor Gordon Brown gave as upbeat a view of the UK economy as one is likely to hear. With a general election likely next May, this assessment should not come as a big surprise. What would be a bigger surprise is if it turns out to be as rosy as the Chancellor says. But by the time we can judge, the Chancellor will hope that the general election is already behind us. Although one suspects that the Chancellor may want the election to be as early as possible, next May is most likely. Between now and then expect to hear a continued upbeat view of the UK, with Thursday's message being repeated in the spring Budget.

There were three key areas to analyse in the PBR:

First, the Treasury's economic forecasts that appear too optimistic;

Second, the Chancellor's fiscal sums. Based on what is already happening this year, the fiscal numbers may turn out worse than expected even if the Chancellor is right on economic growth. If he is wrong on economic growth and the outlook is weaker, then the fiscal numbers could miss by a long way. The risks are on the downside;

Third, the Chancellor highlighted some of the longer-term competitive challenges facing the UK, notably from Asia. Yet if the UK is to face up to these challenges then the whole debate on fiscal policy needs to be shifted within the UK. At present, the relentless upward trend in public spending looks set to continue. This is turn has led to higher taxes and soon could lead to higher borrowing. However, if the UK is to be competitive against Asia, then it is taxes that need to be restrained, both for the corporate and personal sector. If taxes are the main benchmark, then this in turn should be the factor that limits spending and borrowing.

The Economic Numbers

The UK has enjoyed strong growth and low inflation for some time. This track record is in sharp contrast with the Continent and fully justifies the UK's decision not to join the European single currency. Being able to set its own policy framework has been good news for the UK. However, as good as this has been, one wonders whether it will be able to be sustained. Chancellor Gordon Brown clearly thinks so or at least with an election looming he is not prepared to admit otherwise.

After strong growth of 3.25% this year, he still expects the economy to grow 3.0-3.5% next year. By 2006, the spare capacity in the economy will have been used up, leading growth to slow towards its trend. The Treasury now sees trend growth as being 2.75% until the end of 2006 and then, because of demographics, slowing to 2.5% thereafter. If anything this highlights the challenge the UK, as well as Europe, faces compared with the young vibrant economies across Asia.

This upbeat view for 2005 may prove too optimistic, but much depends on the global economy. For not only is the Chancellor expecting still strong growth, he is outlining better balanced growth, with the pace of consumer spending slowing, while both exports and investment rise sharply. On these he may be right about slowing consumption, but it remains to be seen if investment and exports will be as strong as he expects.

UK exports have lost some market share recently, as shown in table 1.