Forget sniping with Treasury, Mervyn King's big worry is debt

Hugo Duncan
30 Jun 2009

Mervyn King famously said his ambition as Governor of the Bank of England was to be "boring". In the past few days, he has been anything but.

His attack on the "truly extraordinary" levels of Government borrowing was as unprecedented as it was damning.

His call for a "clear plan" to reduce the debt infuriated the Treasury and led to accusations he was in cahoots with the Tories.

And his bombshell complaint that he has not been consulted ahead of the Government's imminent White Paper on financial services exposed a growing divide between the Bank of England, the Treasury and the Financial Services Authority.

Three-legged stools are supposed to be stable, but this tripartite system of financial regulation is on the verge of collapse.

The rift is making headlines, but it is also serving to overshadow a key message King is eager to get across - the public finances must be repaired in line with the state of the economy.

"One of the points that doesn't attract sufficient attention in the public debate is that the speed at which the fiscal stimulus should be withdrawn has to be dependent on the state of the economy," he told MPs on the Treasury Select Committee last week.

"There is no point in presenting a profile for the reduction in deficit that is independent of the state of the economy. It has to be dependent on the state of the economy. That is not easy to get across but I think it is a very important part of the debate."

In other words, if the recovery is strong, the debt must be reduced fast, through spending cuts or tax rises or both. If the downturn persists, it will take longer to reduce the deficit.

In the Budget in April, the Chancellor forecast borrowing to fall from a peak of £175 billion this year, or 12.4% of GDP, to £97 billion in 2013-14, or 5.5% of GDP.

King does not think this is fast enough, given the Chancellor's economic growth forecasts of a 3.5% decline in output this year followed by a bullish 1.25% rise next year and 3.5% thereafter.

He wants the debt - which the Organisation for Economic Co-operation and Development reckons will actually peak at a whopping 14% of GDP, or £200 billion, next year - to come down more quickly if the recovery takes this course.

"There will certainly need to be a plan for the lifetime of the next Parliament, contingent on the state of the economy, to show how those deficits will be brought down if the economy recovers to reach levels of deficits below those which were shown in the Budget figures," he said.

"There is just as good a chance that the picture will turn out to be better than was painted in those single numbers as it being worse."

Gordon Brown and his closest allies appear to be in denial over the desperate state of the public finances, either being untruthful about planned spending cuts to draw dividing lines with the Tories or oblivious to the scale of the problem.

But the scale of the problem, and a lack of a credible plan to tackle it, poses risks - another sharp sell-off in sterling, the return of inflation, and a sharp rise in long-term interest rates as the market loses confidence in the UK.

This could strangle the recovery just as it is getting started. It would also send the cost of servicing the Government debt ever higher.

King's view is backed by the OECD, which yesterday said: "The schedule for rebalancing the budget after the current economic downturn abates should be more ambitious.

"There should be more explicit targeting of programmes for expenditure cuts and temporary revenue raising measures should be considered to help expedite the rebalancing of the budget."

Economic recovery depends on confidence. If the markets lose confidence in the UK because there is no credible plan to bring the public finances back under control, any recovery will be short-lived.

The other debt timebomb - pensions

There is a second, hidden, national debt - the public sector pension debt - and it too needs sorting out, writes Hugo Duncan.

It has ballooned in recent years as public sector workers are handed gold-plated pensions that are often worth as much as two-thirds of final salary, index-linked, for life.

For most people in the private sector, such a comfortable retirement is nothing more than a pipe dream.

The last Government estimate of how much this costs the taxpayer was made in the long-term public finance report published in March 2008 - 1.5% of GDP in 2007-8, or £21 billion, rising by a third to 2% in the next 20 years, or £28 billion.

The total liability - what all the promises to current and retir ed public sector workers adds up to - is reckoned to be £1.2 trillion, three times higher than in the US, according to the British-North American Committee this week.

One way of reducing the cost would be to only provide final-salary pensions to public servants at the sharp end, for those on the front line.

Thus, nurses on the wards but not those elevated to oversee them in the office would receive top-notch pensions.

So too teachers, but not headmasters, doctors below the rank of consultant, social workers and probation officers but not their team leaders.

Soldiers, sailors and airmen up to a certain rank would qualify, so too rank-and-file police officers and firefighters.

Those promoted would be entitled to an index-linked pension based on the salary they last had before promotion, but beyond that would need to join a money purchase scheme like in the private sector, with contributions from the employee and the state.

If anyone is dissuaded from promotion as a result, let them stay on the frontline.

Importantly, MPs and civil servants would be excluded from the gold-plated deals, putting them on the same footing as most in the private sector dependent on the economy and not the taxpayer for their pensions.

It would have to be introduced over the long term so as not to penalise those nearing retirement now, and would only reduce the burden on the taxpayer slowly.

But, given the erosion of private sector pensions, the desperate state of the Government finances, and the pain the taxpayer is set to endure, it is worth some thought.