by Paul Amery
Q. What’s the common theme running through the Greek rescue package and the UK’s post-budget discussion?
A. Deficit reduction and, more specifically, public spending cuts of a scale none of us will have seen in our lifetimes.
According to an analysis in today’s Economist, Greece is facing an adjustment in its primary budget balance of 13.5% of GDP over the next five years in order to bring its deficit down from 13% to 3%. That won’t halt the upward trend in public debt, which will rise from 113% of GDP in 2009 to 152% in 2014, but it’s the least that the journal’s analysts think is necessary to stabilise the situation. And nominal GDP in Greece in 2014 is forecast to be €226 billion, 5% short of 2009’s €238 billion.
This is the harsh reality of the adjustments to be made, even while the announcement of yesterday’s joint EU-IMF support plan is in the headlines.
In the UK, it took only a day after a budget criticised for being short on detail about deficit reduction for the chancellor, Alastair Darling, to concede in a BBC interview that spending cuts would be tougher than anything experienced under the Thatcher government of the early 1980s.
If the government wishes to ring-fence spending on health and education, the Institute of Fiscal Studies has concluded, other departments like transport, housing and defence will have their budgets slashed by a massive 25%.
If this sounds unbelievable for those of us used to a constant year-in, year-out ratcheting up of government expenditure, it helps to remember that there’s a living laboratory for such an experiment: Ireland.
There, a study has recently been released by the Irish Business and Employers Confederation under the optimistic title, “International Confidence Returning.”
The facts of Ireland’s deflation revealed in the document are sobering, however: house prices down 30%, residential rents down 25%, office rents down 39%, unit labour costs expected to fall 7% by 2011, a reduction in public sector pay of 14%.
And all this has merely stabilised the deficit at double digit levels: for 2010, the budget shortfall is forecast at 11.6%, still far short of balance.
The Irish have been rewarded for their fiscal efforts by a relative narrowing of their credit default swap spread over the last year, when measured against European neighbours, as we covered in a feature earlier this week. However, the country remains in the top five riskiest European sovereign borrowers, and Ireland is still paying a spread of around 150 basis points over Germany on its 10-year bonds.
It’s hard to see how the UK and Greece, to give only two more examples of countries facing similar budget difficulties, can tighten their belts to the extent being forecast without a slide into outright deflation similar to the kind being experienced by Ireland.
I know there can be deflationary booms, where company profitability rises in a falling price environment, but shrinking nominal GDP also threatens competitive currency devaluations and trade barriers while increasing social tensions. There are also few, if any, analysts forecasting actual falls in company revenues.
If it’s “welcome to Ireland” for an increasing number of European countries, it’s hard to see how a severe second dip can be avoided for economies and markets.