Hamish McRae: A new language to discuss spending

Politics are back but for the moment at least economics is on hold. The new parliament is functioning but the massive shift in economic policy that is about to occur is not yet upon us. We have to wait for the emergency budget on 22 June for that. Meanwhile, there will be an unnatural calm, a phoney war, before the inevitable blitz is unleashed upon us. We know this will be unpleasant for we can see the outline of what will happen. But we cannot hope to see the detail, partly because none of us yet have the figures, and partly because it is hard to go from the general to the particular. We know that x billions have to come out of public spending and/or be added to taxation. But we cannot quite think through what this might mean.

Even the structure of the debate has yet to take shape. We are still hearing the political language of the past. It is "seeking efficiencies", or "preserving investment", or "protecting from cuts". It is language built up over a couple of generations during which, with a few brief interruptions, government revenues would rise reasonably steadily. The Government was in the position of an employee in a steady job, knowing he or she would get regular increases in the monthly salary even allowing for inflation. So the decisions were about apportioning that salary in a sensible way. There were little tweaks in the language with, for example, New Labour substituting the word "investment" for "spending", and there were accounting changes such as getting private finance to pay for capital projects. But privatisation apart, the key assumptions behind policy were unchanged.

All that will be swept away in the life of this Parliament. It could well turn out to be the first full-term parliament since the Second World War where government spending in its final year is lower in real terms than during its initial year. We have had hints of the difficulties ahead from George Osborne's references to Greece. We have had the nice joke of the outgoing Chief Secretary leaving a note for his predecessor saying that there was no money left. We have had, just yesterday, the revelation that senior civil servants formally protested at government spending decisions in its final months of office as they feared these would not offer value for money. But even ahead of that we had the creation of the Office for Budget Responsibility, intended to give an independent check on the validity of Treasury forecasts.

This office will be hugely important. Treasury forecasts on overall economic growth have not been at all bad compared with the others but its forecasts of government revenue have pretty consistently over-estimated tax revenues – or at least they did when Gordon Brown was Chancellor. So some kind of independent verification of Treasury numbers has been essential. This office, however, is merely a UK response to a much wider problem. Just as different countries tried different institutional mechanisms to cope with the inflationary disaster of the 1970s and 1980s, so different countries will now try various mechanisms to cope with the present fiscal disaster. The eurozone will try to impose much stricter controls on its member states, and discussions on that have just begun. I expect the US will revise its constitutional arrangements, with more effective restrictions on the ability of successive administrations to build up national debt.

This will be a 10-year process and it will happen in most developed countries. Our last government may have left UK finances in a particularly parlous state. But it is not just a British problem. Even before the last recession, the debt-to-GDP ratios in the large developed economies taken as a whole were on an upward trend. Governments everywhere were borrowing too much; governments everywhere were finding tax receipts were falling short of the demand for public services. But they could patch it, as we did, and hope for something to turn up. What did turn up was not a stroke of luck, a windfall tax gain such as we received from auctioning the 3G spectrum. What turned up was a humdinger of a recession. But, and this is a measure of our fiscal failure, this recession in Britain at least looks like being no more serious than that of the early 1980s.

So what will happen? Well, just as we will stumble towards new institutional arrangements to control our deficit, our politicians will stumble towards a new language to explain the changed nature of government. If the amount you can spend is going down not up, you have to have to explain what governments can and cannot do. You have of course to be more open about the numbers but that is the easy bit. You could, I suppose, heap some blame on your predecessors, but that does not really help. No, you have to explain why the proposition underlying Western politics since the Second World War – that governments can go on providing more services without significantly higher taxes – is wrong. That game is over. Demography and debts have ended it forever.

People who fear that the policy of the Government is to inflate away the real value of the national debt will find those fears reinforced by the inflation figures yesterday. The Governor has now had to write no less than seven letters to Chancellors explaining why inflation is above target, and not a single one as to why it has been below. The retail price index is now 5.3 per cent, the highest since 1991. Investors who argue that the Bank of England has been far too complacent about inflation have a right to feel justified, while savers who are getting less than 1 per cent interest have a right to feel they are being cheated. So when will the first rise in interest rates or the running down of "QE" come through? Before the autumn is out.

h.mcrae@independent.co.uk

For further reading

Tomorrow: International Studies by Adrian Hamilton