Downturn threatens spending plans

GORDON Brown demonstrated extraordinary bravery in his spending review. With financial markets crashing around the globe, he stood his ground, refused to give in to short-term thinking and, as promised, delivered huge new spending on education, health and transport.

As far as the City of London is concerned, the events in the Commons might as well have been on a far-off planet. Even as Brown was on his feet, share prices were crashing with the FTSE falling 229.6 points to below 4,000.

In his speech Brown made only passing reference to the instability on the financial markets. But he and his advisers know, in their heart of hearts, that the one thing that could come between Brown and his plans for a big lift in spending is a downturn in the economy.

Boosting the rate of increase in public spending beyond the core rate of growth and wealth creation can be done only by raising the levels of borrowing. While Brown's prudence so far has enabled him to avoid this, he will quickly run into difficulty if the downturn continues over several years.

At the time of the Budget in April, the Chancellor forecast that the economy would grow by 2% to 2.5% in 2002, rising to 3% to 3.5% in 2003. What has happened since suggests that his promised rates might be greatly exaggerated.

In the first half of this year, despite the boom in the housing market, the economy has struggled to grow at all.

What will be really worrying for the Chancellor is the steep slide in financial markets.

It is easy to argue that events in New York are a long way away and that Britain can ignore the corporate scandals in the U.S. But when Wall Street sneezes the rest of the world, including Britain, catches a cold. The collapse here is a reflection of the fact that share prices in the US have fallen further in the last 12 months than at any time since World War II and that we could soon be back in the territory of the 1930s.

Falling share prices hit business and consumer confidence and provide early signals of difficulty, possibly recession, in the economy of manufacturing and work.

Even Gordon Brown's good economic sense, which has brought national debt down to its lowest level this century, cannot protect the public finances from broader economic trends.

At the core of a nation's budget are two fundamentals. One is the amount of revenues and charges which the Government collects from us each year, a figure which will rise to £407.2bn next April when Brown adds a 1% surcharge on the National Insurance contributions paid by employers and employees.

The other key figure is public spending, where the totals are to rise from £418.4bn next year to £511.4bn by 2005-06.

The difference between these two numbers is either the budget surplus (the main feature of Brown's period in office) or the budget deficit, which is now beginning to arrive.

It takes a very small change in the growth of the economy to make a serious impact on the size of this deficit. If growth falls short of projections, then taxes and government revenues also plummet.

There can be no doubt that difficulties on the world financial markets will place corporate profits under pressure, and that this will lower the Government's tax take.

Similarly, should the slowdown damage full employment then the savings that Brown has made on benefits could vanish overnight.

Moreover, there must be concerns that in his budget planning Brown has underestimated the levels of inflation building up in the public sector.

In the first quarter of the year, public sector inflation rose by 6.5% against the 2.5% included in the spending review projections. If price increases were to continue at this level, Brown's public spending largesse would buy a smaller quantity of goods and services.

This is not to say that all developments in the financial markets or the public sector are working against his ambitious plans.

The revival in the value of the euro should help to make manufactured goods more competitive in Europe at time when there have been new signs of life in the manufacturing sector.

In the end, Brown's great spending gamble requires the economy to grow and keep on growing without drawing breath.

Otherwise, he will be forced away from stability into the cycle of tax and spend which in the past has delivered only grief for the nation.

The spending review in detail