Sunday 3 January 2010 11:17 pm

Why 2010 will be make or break for UK

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IT is hard to believe that just three years ago the UK economy was still being lauded as a great success story; our fall from grace has been spectacular. In 2007, London was overtaking New York as the financial capital of the world, with a resurgent Britannia gracing the covers of US news magazines; today, as the new decade begins, we are being bracketed with the likes of Italy and Greece as nations that might soon default on our national debt.

Of course, we remain a wealthy nation and London a prodigious financial powerhouse. We are no longer in recession, the banks are recovering, the equity and credit markets are doing well, unemployment is improving and global demand is bouncing back. But to mention all of this is to miss the point: 2010 will be the year we either face up to our oversized public sector and runaway budget deficit – or the year our bubble truly bursts, puncturing with it all of our illusions of prosperity.

The last couple of years have been extremely tough, with the economy shrinking drastically and hundreds of thousands losing their jobs; but much of the necessary adjustment has been delayed. The property and financial bubble has been replaced by a public sector bubble, propped up by quantitative easing, the Bank of England’s great gilt-buying experiment. The OECD’s latest stats suggest that public spending will account for 54.1 per cent of our GDP this year; one pound out of five of this will be borrowed, a dangerous and unsustainable state of
affairs, especially when quantitative easing is finally halted at some point this year. The deficit is set to remain stuck in double-digits for the foreseeable future, with the national debt on course to hit 100 per cent of GDP middecade. It is the kind of trajectory that would have made Icarus proud.

Gordon Brown’s implicit claim on Andrew Marr’s BBC show yesterday that his 50p top tax rate and other hikes will be enough is laughable. The deficit will be at least £180bn this year; the taxes in question are expected to raise under 5 per cent of what is needed (and in practice will yield even less). The Tories’ plans are barely any better: they have yet to explain in any detail where they will find the remaining 95 per cent.

Most consumers and investors don’t fully grasp the extent of the cutbacks (and likely tax hikes) that will be necessary to put us back on track, partly because the politicians have failed to be honest about the scale of the crisis. The public is aware that we are in trouble; but it has yet to accept that Irish-style swingeing spending cuts, including public sector pay reductions, are now looking inevitable. This will make it even harder for any party to take truly tough decisions – and hence make a ratings downgrade, sharply higher interest rates and a sterling crisis more likely.

The problem with reality is that it eventually catches up with us. Governments can’t go on spending as much as they want forever; like the rest of us, they have a budget constraint. How we deal with that reality will be the story of the year; in the short-term at least, the election will be a mere sub-set of this greater story. The winners’ job will be to ensure that the 2010s don’t turn out to be another 1970s, a wasted and debilitating decade of decline and IMF bailouts.

Fortunately, I’m an optimist by nature – which is why I still fell able to wish all of our readers a very Happy New Year. It’s good to be back.