Budget 2011 – The Impact of Events on Deficit Reduction Plans

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 By Grahame Steed, Managing Editor, Government Opportunities

Prime Minister Harold Macmillan’s often quoted words may have been reverberating in George Osborne’s mind as he put the finishing touches to his Budget speech this morning. Macmillan once remarked that what he most feared were “Events, dear boy, events”. For Osborne, an already difficult Budget has been made yet more challenging by recent events in Asia, North Africa and the Middle East.

Apart from the awful human cost of the earthquake and tsunami in Japan and the popular uprising in Libya, these events also have immediate economic consequences – of which the price of oil is the common component. Japan’s nuclear issues mean that, at least in the short term, its dependence on oil is set to rise, so putting upward pressure on oil prices. While Libya may be a minor player in oil exports, at least when compared to Saudi Arabia or Kuwait, the fear of its turmoil spreading across the Middle East – if it hasn’t already done so – is enough to push oil prices still higher. Just to add to Osborne’s woes, there is the very real cost of enforcing the no-fly zone in Libyan air space. A round trip for a Tornado aircraft to fly from the UK to Libya and back is estimated at £200,000: so it’s easy to run up huge costs for that alone. The no-fly zone has been strongly supported across Government; but we will see how strong that support remains when the bill arrives in the post. The funding for the no-fly zone may come from the reserves, but it is still a real cost.

Which returns us to the issue of the Budget. The world is not a predictable place, but it is a highly connected one. The price of oil is most keenly felt when it is converted into fuel – fuel that powers not only our cars but also the vast fleets of public sector vehicles. Fuel that not only warms our homes, but also powers council offices and heats municipal swimming pools. At a time of relentless focus on deficit reduction, it is painful to see hard-won savings eroded by increasing commodity costs. It is bad enough that fuel prices have soared (I would say ‘rocketed’, but we can’t afford the fuel to fly one), but the prices of other commodities, such as wheat, are also having a serious impact on government budgets, particularly those of local authorities.   

The Organisation for Economic Co-operation and Development (OECD) has, in effect, endorsed Osborne’s deficit reduction plan; however, it has done so on the basis of projected growth figures for the economy that now look suspect; not least given yesterday’s Consumer Price Index annual inflation figure of 4.4%. Given the impact on household budgets of spikes in food and fuel costs – not to mention stagnant or falling incomes and the still very real insecurity around jobs – is it realistic to expect the hard-pressed consumer to power the UK into the faster economic growth required to balance the spending cuts? Combine this with a similar squeeze on the Government’s household budget, and it’s hard to see where growth can come from, particularly since the Office for Budgetary Responsibility has now cut its growth forecast for 2011 from 2.1% to 1.7%. While in his Budget address Osborne has said that the focus is now on reforming the nation’s economy for enduring growth and job creation, it is difficult to see where even this growth will come from.

Osborne has hailed the success of the deficit reduction plan – and, whether you support it or oppose it, it has created a good deal of momentum already. However, the balance between deficit reduction and maintaining the regeneration of the UK’s economy is a fine one. Instead of obsessing over a fixed target of deficit reduction, irrespective of external factors, perhaps the Chancellor should be considering an alternative, phased approach. To put it back into householder terms, there’s no point in paying off the entire balance of your credit card in one go if it means existing without food and defaulting on mortgage payments.

So, Budget 2011 has provided its normal mix of interesting new taxes – few tears will be shed for the owners of private jets, I suspect – and a reinforcing of Government’s determination to remain on its current deficit reduction path. Whether this should be admired as determination or criticised as stubbornness is a fascinating debate. Only events will show.