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Economics focus: Public finances on the mend

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Cutting the budget deficit has proved harder than the government hoped, partly as a result of the weakness of the recovery. But recent news on borrowing has been better, raising hopes that the deficit will drop to under £100bn this year and fall faster in future years.

Treasury ministers and officials are fond of saying that they do not give a running commentary on the state of the economy. They usually say this, it should be said, when the figures are disappointing. In my experience, they are happy to comment on good news.

The thing with the public finances is that it is hard to do anything other than give a running commentary. New information is available each month and it can change the picture dramatically. This time last year, for example, it appeared that George Osborne’s fiscal strategy was being blown badly off course.

The monthly numbers then suggested, even to respected analysts, that government borrowing in the 2012/13 fiscal year was heading for £135bn or more, indicating not only that the chancellor was failing to reduce the deficit (at the time, the previous year’s number was just over £120bn), but that it was going up again. The alarm bells were ringing.

Then, however, the run of numbers started to look better and Osborne moved heaven and earth in his March budget to prevent a big overshoot. The latest estimate for 2012/13 borrowing, £115.7bn, is not only a long way below £135bn but below the £118.5bn figure currently estimated for 2011/12.

Having peaked at £157.9bn in 2009/10, the deficit has now dropped by almost £40bn. As a percentage of gross domestic product, annual borrowing has fallen from 11% to 7.4%, hence the government’s claim that it has reduced the deficit by a third.

Of course, £115.7bn is still a very large number, as is 7.4% of GDP. Though there have been years during and immediately after wars when annual borrowing has been higher relative to the size of the economy, there is only one properly peacetime year, 1993/94, when borrowing was higher, 7.5% of GDP, until the current crisis. The previous high, just under 7%, was 1975/76, when the Labour government had to seek a rescue from the International Monetary Fund.

So last year’s deficit was the fifth largest in ‘normal’ times on record. And, while reducing it by a third is progress, it is slow progress compared with some previous periods. By this stage in the 1990s, the deficit was less than half its peak. The pattern of deficit reduction, in fact, is more like the 1970s, when it took time to come down, and nobody would see that period as one to emulate.

Fortunately, it appears that we might now be starting to move into more promising territory. Though the Treasury has always insisted that the borrowing problem it was seeking to eliminate was structural (requiring radical surgery) rather than cyclical, it is undoubtedly the case that slow growth makes it harder to make large inroads into borrowing. In any case, weak growth turns the cyclical into the structural, for example by increasing the number of long-term unemployed people who are harder to get back into work.

So the return of growth is good news, and if it lasts, it is even better. Already there are signs that stronger growth is exerting faster downward pressure on the deficit. Though public sector borrowing in August, £13.2bn, was a large number, it was £1.3bn lower than a year earlier. Borrowing for the first five months of this fiscal year was £46.8bn, adjusted for special factors, compared with £50.5bn in the corresponding period of 2012/13.

Most encouraging of all, the growth in tax receipts this fiscal year is outstripping the growth in public spending. Tax receipts on production (including VAT) are up 3.8% and taxes on income and wealth are up 3.3%, while current spending has risen by 2.6%.

Given that initial estimates for public borrowing tend to be revised lower over time and remembering what was happening a year ago, it is quite possible the underlying picture is even better than the figures suggest. Some analysts are suggesting that this year’s deficit could come in at under £100bn, with the prospect of bigger reductions in the years to come. Though Osborne may never get back on the deficit reduction track he set out in June 2010, he could get a lot closer to it than once seemed possible.

One vital ingredient in all this, of course, is that the recovery continues to build. Here, while you expect the politicians to be optimistic, not only are independent forecasters revising up their predictions for the economy – some now suggest growth of close to 3% next year – but the Bank of England looks increasingly convinced that things are decisively picking up.

Two members of the Bank’s monetary policy committee have recently given voice to this optimism. Ben Broadbent pointed out that the business surveys are consistent with annualised private sector growth of around 5% and, while he does not necessarily expect this to be reflected fully in the official figures, thinks the economy is responding to measures taken by the Bank, along with other central banks. David Miles, his colleague, sees growth at 2.5% to 3.5% and that there is a good chance it will prove sustainable.

There have been false dawns before, for both growth and the deficit. It took a while for the penny to drop a couple of years ago that reducing borrowing was proving harder than hoped. Miles says, however, that the recovery prospect is better than at any time since he joined the MPC in 2009. A virtuous circle of stronger growth and falling borrowing is not guaranteed. But it certainly looks possible.