Falling to the borrowing habit

The British Chancellor of the Exchequer Alistair Darling announced the budget for 2009 and revealed that the government plans to borrow £175 billion (Dh954.6 billion), which is about 12.5 per cent of national income.

Although the amount is substantial and does deserve serious attention, the government's announcement that 80 per cent of it was structural is even more worrying. What is meant by structural debt is that it's borrowing that will take place whether there is an economic recovery or not.

Most observers expected a significant increase in debt this year because of the rescue packages that had previously been announced; however no one realised this is what they can expect in the coming year, too. It is now clear the chances of the British government having to be bailed out by the IMF are very real and, even if this does not happen, the fact that people are talking about it does not bode well for the future.

In the Pre-Budget Report (PBR), the structural budget deficit for 2010-11 was estimated at around 7.2 per cent of national income and now it has been revised up to 9.8 per cent in the budget. The government believed before the crisis that the financial sector in the country - which contributed about 25 per cent of national income - would always be able to do so. Not only this, the sector was also responsible for the growth in government revenues over the past decade. Now that this sector has taken a serious hit and will unlikely be the same again because of the tighter regulations that will be put in place, the productive capacity of the country has effectively been dented and its structural debt has increased as a result.

The UK's manufacturing base has been contracting for a very long time and this cannot be blamed solely on the Labour government, but on the United Kingdom's over-dependence on the service sector. To remedy this, the Chancellor has chosen the most populist of all solutions - tax the rich. He has increased income tax for those earning above £150,000 to 50 per cent. This solution will bring at best short-term benefits at a very high cost because it gives an incentive to companies and individuals to relocate, especially after the government has given the impression it will go after the rich whenever it feels like it needs to.

And as for the government bonds it hopes to issue to fill the hole in the budget, it is highly questionable whether it can do so since the last time it tried the market did not buy all of them. Foreign investors and pension funds are increasingly wary of British government bonds.

Every story has an end, but not necessarily a beginning. It is sometimes difficult to know where to start and therefore an arbitrary point is often selected. While Gordon Brown was chancellor of the exchequer, a number of people kept on raising the red flag but New Labour kept on convincing people that the era of boom and bust was over.

This allowed the government to borrow and spend even higher amounts to improve public services without the electorate realising they were being taken off a cliff. The Tory Party needs to take some of the blame because it failed to present an effective opposition capable of doing a better job. Had they done so, their warnings could have been heeded rather than be ignored as conservative rambling.

It is safe to say, that the British economy is in the worst possible situation it could possibly be in. Out of all the large economies, it faces the greatest difficulty. And the reason for this can be summed up simply; the government took the revenues it collected in the past "boom" as being "part of a permanent financial landscape".

All its forecasts and projections were based on spending and never factored the possibility that there may be a drop in tax revenues. For anyone who still believes that the economic crisis is not as bad as some people say it is, just look at the borrowing projections needed to keep government spending and services at the level they are now. To borrow a phrase and may be coin one, "we were living on borrowed times and now we are going to borrow some more".

- Mohammad Fathi is an economist and independent consultant based in Vienna.