The real story of the Budget is not to be found in the striking figures concerning the government’s borrowing requirement. These figures are symptomatic of a much deeper crisis which is rooted in Britain’s economic history over a 30 year period.
The fundamental problem facing the UK is the shrinkage of the manufacturing sector. This has been a common feature in all developed economies during the last forty or fifty years, but the UK experience has been more intense than in many comparable economies. In 1960 manufacturing accounted for 35 per cent of the UK GDP. It fell back from this level over the subsequent twenty years, but its share still remained over 30 per cent. The Thatcher years saw a much more rapid decline, as large parts of British industry closed down while the financial and service sectors expanded. This process slowed down, and was for a time even reversed during the Major Premiership, but by the end of the 1990s manufacturing was contributing a little over 20 per cent to the GDP. The contraction was resumed after 2000, and by 2007 slightly over 16 per cent of the GDP could be attributed to manufacturing.
The retreat of the manufacturing sector has been accompanied by a deteriorating balance of payments current account. Even though there were times in the 1950s and 1960s when this went into the red, it was very rare for a balance of payments deficit to be worth more than – 1 per cent of the GDP. The special circumstances of the oil crisis in 1973 led to a –4 per cent figure in 1974, but the ‘old Labour’ Wilson and Callaghan governments trans-formed this into a 0.5 per cent surplus by 1978. Thereafter the position became far more volatile, and by the end of the 1980s the current account deficit was approaching –5 per cent of the GDP. The partial recovery of the manufacturing sector in the 1990s was accompanied by a marked improvement in the current account, which saw a deficit worth just –0.1 per cent of national income by 1997. Since then, however, there has been a return to the kind of deficit seen in the 1980s. After 1999 the current account deficit consistently amounted to at least –2 per cent of the GDP, and rose to –3.4 per cent and –2.9 per cent in 2006 and 2007 respectively.
For many years this weak external position did not create problems for the domestic economy. Living standards rose and there was continuous economic growth from the early 1990s until early 2008. During the 1960s and 1970s successive governments had struggled to generate current account surpluses, believing that prosperity could not be sustained in their absence. Now it seemed as if those fears had been misguided, and the country could afford to forget the external position. But it was this conviction which was illusory: the expansion of the last 12 years in particular has resulted from significant inflows of foreign capital and a dramatic expansion of credit, accompanied by the growth of the financial sector in conjunction with ingenious virtual products designed to take risk out of lending. The process was however largely built on the belief that asset prices, notably property, would continue to rise indefinitely. And indeed, the returns from speculative ventures were so lucrative that a giant inverted pyramid of lending developed, with the consequences with which we are all familiar.
The arrival of the global crisis in 2007 hit the UK especially hard. As asset prices fell, money and credit disappeared from the banks, which were nationalised or partially nationalised to prevent a catastrophic failure within the UK financial sector. The cushion of lending, which had sustained living standards by compensating for the diminishing share of exports, deflated fast. Now the UK has to make a serious adjustment, since the credit which had allowed its citizens to enjoy the good years has gone and is unlikely to return very soon, and even when it does the probability of it reaching its old levels must be regarded as highly remote. The resulting fall in economic activity is what is behind the collapse in tax revenues and the very large borrowing revealed in yesterday’s Budget. The manufacturing base of the economy is not large enough to compensate, via exports, for the loss of income generated by the financial crisis.
The adjustment
What is the form of adjustment? The economy needs a stronger manufacturing sector, capable of earning more in foreign exchange than has been customary over the past decade. The government’s steps in the direction of industrial activism and selective intervention are steps in this direction, but the volume of resources available is limited as a result of the borrowing requirement. The government has rightly turned away from cutting public spending commitments and imposing tax increases in the middle of a recession, but it will need to spend more on industrial regeneration over the coming decade than is currently planned if the gap in income left by the financial crisis is to be filled. Some of the extra spending will come from resumed growth, but some may have to come from a diversion of funds away from other areas which are less immediately useful from the perspective of augmenting the nation’s wealth. These could include expensive defence commitments (both strategic and in terms of weapons systems such as Eurofighter and Trident), IT projects in the public sector, and the expansion of the universities, at least on the time-scale envisaged at the moment. This is a process which will take years. In the meantime, British people have to face static or declining standards of living, characterised by austerity in pay, higher taxes, and large-scale unemployment. This is the real story of a Budget which has revealed the true cost to a country of living beyond its means for over a generation.
Dr Scott Newton is profiled at <www.cf.ac.uk/hisar/people/sn/>