Evercore Pan Asset

This week we heard from the UK government how it intends to carry forward its plans to bring down the very large UK public sector deficit over the next four years. The government has revealed that its main aim is to obtain significant welfare savings by getting more people off benefits and back into work. There are two main elements to this policy. The first is the introduction of a more wide ranging work programme, to offer support and training to all who are out of a job, and to ensure no-one continues on benefit who can obtain work. This is backed up by a new ceiling on total benefits any out of work individual or family can receive.  The second is longer term, relying on new computer systems and a thorough revision of benefit administration, going over to a single benefit that ensures it is always worthwhile working. The talk is of the whole reform taking two parliaments or around ten years to see through.

The Chancellor did have one surprise in his package. He decided to increase capital spending by £8.6 billion over the next four years, so total spending and borrowing also rise by the same amount. This takes total planned borrowing to £460 billion over the lifetime of this Parliament. The capital budget is being appraised to find projects that have a favourable impact on economic growth. Transport is one of the main beneficiaries.

Contributions to faster growth are going to be needed. The strategy hinges on tax revenues rising by £176 billion extra a year in 2014-15 compared to 2009-10. This rests on the assumption of above trend growth for each of the four years from 2011. So far this year growth and job growth has been good, but despite this the latest borrowing figures make poor reading. September’s borrowing hit a new high for that month. Revenue growth from Income Tax was weak. This probably reflects the way many companies paid bonuses prior to the increase in the higher tax rate in April, and the slower rate of growth of earnings generally in the economy.

The government’s critics come from both sides of the argument over whether to cut more and faster or less and more slowly. The public sector Unions and the official Opposition in Parliament urge the Chancellor to cut less and cut more slowly. They fear the impact of lost public sector jobs and reduced spending power from lower total benefit awards will be to depress the economy further and even to create a double dip recession. Others, including the IFS, think the Chancellor may fall short of his deficit reduction aims, as the spending may drift higher and the revenues come in lower than planned.

At Evercore Pan the house view remains that the UK government has done enough to pull the UK back from the danger of an Irish or Greek type funding crisis. The international financial community can see the government intends to take the deficit seriously and is seeking to curb spending and boost revenues to tackle it. There remain risks in the UK’s position owing to the inheritance of a heavily indebted country in both public and private sectors, so we continue to see better investment opportunities in faster growing parts of the world without that same debt overhang. The government’s strategy seeks to find the mid-point between cutting too much and making it difficult to retain public and employee support in the public sector, and cutting too little leaving the UK borrowing too much. Now all rests on how successful the government is at creating the conditions for a fast and sustained private sector recovery.