UK still in recession

The UK today confirmed its position as the only G20 country still mired in recession. While revised upward from an earlier estimate of 0.3%, the economy contracted by 0.2% in the third quarter of 2009.

In recent weeks analysts predicted that today’s figure would show the country has already exited the recession. Instead Britain has now seen six successive quarters of contraction – its longest downturn since the 1930s. The loss of output since early 2008 now stands at 6.03%.

In a new blow to Chancellor Darling’s optimistic forecasts, the economy was dragged down by declining services and industrial production output. This was partially offset by a rebound in construction, according to data from the Office for National Statistics.

Darling’s forecasts of 1-1.5% GDP growth in 2010 and 3.5% in 2011 are seen by analysts as overly optimistic. Many suggest the UK may struggle to grow at all next year. The OECD estimates the UK economy will expand by 1.2% in 2010 and 2.2% in 2011.

If the Treasury’s forecasts prove wrong, the government will have to find yet more money to cover its spending. Borrowing has reached a record £20.3 billion in November alone, and the 2009 budget deficit is expected to come to a staggering £178-185 billion.

That represents more than 13% of GDP; the 2010 deficit is also likely to reach 13-14% of GDP. (Which is higher than Greece’s 12.7%. Yet, while Greece is expected to cut its deficit by nearly 4% of GDP next year, the UK government has opted to do nothing to reduce Britain’s deficit in 2010.)

Today’s data also showed the UK household saving ratio to have reached 8.6%, the highest level since 1998. Just before the start of the recession in early 2008 it stood at a record low of -0.7%.

US GDP growth at 2.2% in QIII

In the US third quarter GDP growth has been revised down to 2.2%, from an earlier estimate of 2.8%. It was the first quarter of economic growth after four quarters of contraction.

Analysts are revising upward their forecasts for 2010 GDP growth. The latest predictions expect the US economy to expand by 2 to 5% (depending on forecaster), signaling possibly a stronger snap back from the most severe recession in three decades.

The National Association of Business Economists raised its forecast of 2010 growth to 3.2%, which coincides with the figure the White House used in its latest economic outlook. OECD, on the other hand, expects a 2.5% growth in the US next year. Michael Mussa, a former IMF economist, now with the Peterson Institute for International Studies, expects the economy to grow at a rate of 5% in 2010, predicting a strong recovery in both growth and jobs.

The big question marks that will influence next year’s growth are the consumers and the housing sector. Although analysts expect to see job growth next spring, unemployment will remain high (likely around the 9-10% mark).

With historically high levels of household debt, consumer spending growth may remain weak for much of next year. Households are likely to prioritize paying down debt at the expense of personal spending. While house prices seem to have bottomed out, housing will also unlikely be the engine of growth it has been in recent years.

Eurozone set for weak 2010 growth

After five quarters of falling output the 16-nation eurozone exited the recession in the third quarter, posting a 0.4% GDP growth. (The 27-member EU saw GDP up by 0.3% in QIII.)

According to Eurostat, a jump in inventories and exports were the main drivers of economic growth in QIII, while household consumption remained weak amidst high unemployment (near 10%).

Economic growth is expected to be low at 0.9-1% in 2010, according to OECD and the European Commission.

Chancellor Alistair Darling unveiled his politically motivated pre-budget report today. Let’s look at the details.

Bonus super-tax and new higher earner taxes

A new temporary super-tax on bank bonuses comes into effect immediately. Banks (incl. UK subsidiaries of foreign banks) will pay 50% tax on bonuses over £25,000 (to include shares, options and temporary salary increases). The bankers will of course then still be hit with the new 50% income tax on earnings.

The bonus tax is estimated to raise just £550 million in revenue, so it’s clearly just a populist measure for Brown’s semi-socialist government to grab votes. Bankers are an easy target and the recent witch hunt has been entirely in tune with Labour’s politics of envy and class war.

Thousands more of higher earners will also be hit with the new 50% income tax rate as it is widened to include not only pay but also pensions. In essence it was extended to those earning £130,000 or more.

Middle class tax grab

But it’s not just higher earners who will suffer the consequences of Labour’s mismanagement of public finances and the economy.

The threshold for higher-rate (40%) income tax will be frozen. That means people earning just £43,000 will pay more tax, costing workers £400 million a year.

And, in an additional massive middle class tax grab, the announced National Insurance (NI; income tax in all but name) rise will hit anyone earning £20,000 a year or more.

At present 11% of workers’ wages go toward National Insurance. From 2011 NI contributions will go up to 12% for all workers earning more than £20,000 a year. Those on more than £44,000 also face a second hit, paying 2% rather than 1% on their pay above that threshold. The increase in NI is to raise £4.5 billion a year from 2011/12.

On top of the employee contributions, the employers pay 12.8% of their workers’ salaries in NI contributions. This will increase to 13.8%. The raise of NI is a tax on jobs, pure and simple. And it comes at the time when UK’s economic recovery is incredibly fragile.

Finally, the inheritance tax threshold will be frozen at £325,000, rather than raised to £350,000 as previously promised.

Balancing the budget?

Darling expects GDP to drop by 4.7% in 2009, the worst peacetime performance since 1921. (His last prediction earlier this year was of 3.5%.) He expects the economy to grow by 1-1.5% in 2010 and 3.75% in 2011 – extremely optimistic figures and likely to be proven wrong, as so many of his past forecasts.

The pre-budget report shows plans to borrow nearly £800 billion over 6 years, taking the 2014/15 national debt to just under £1.5 trillion. Of course the real number is far higher, as the government figures do not include the public sector pensions deficit estimated at £1.2 trillion.

In a further upward revision of earlier forecasts, the government will, in 2009/10, spend £178 billion more than it receives in tax – equal to 12.6% of GDP. Next year, the deficit is estimated at £176 billion.

The Chancellor aims to cut UK’s deficit to 5.5% of GDP by 2013-14. However, we’re yet to see any clear and viable plan for that to be achieved. Britain’s credibility and credit rating depend on that, so let’s see what Darling proposes to do to cut spending.

Where are the much needed public spending cuts?

While Ireland is slashing spending – by way of benefit and public sector pay cuts – to the tune of 4 billion euro, you would be hard pressed to find many meaningful measures in Darling’s pre-budget report. (Irish budget deficit of around 12% is comparable with that of the UK.)

The Chancellor plans to impose a 1% cap on public sector pay rises (as opposed to the Irish 6% cuts in public sector wages and up to 20% for highest earning public servants) for two years. Even that is postponed until 2011. From 2012, government contributions to public sector pensions will be frozen.

Worse still, the Chancellor insisted key services will be safe and ring fenced. NHS, schools, police are guaranteed to see their budgets rise at least in line with inflation.

VAT will return to 17.5% from 1 January 2010, as expected.

Cuts? It’s more spending instead!

While any sensible observer might have expected severe spending cuts in a country on the verge of bankruptcy, Darling has laid out Labour’s plans for 2010 and beyond: tax more and spend more.

To please the party’s core voters, child and disability benefits will be increased by 1.5% from next April. Basic state pension will be raised by 2.5%. And, bizarrely, bingo tax will be cut. In fact, Labour will be spending an extra £7.7 billion in 2011/12 and £6.9 billion the following year.

Conclusion

So there we have it. Instead of much needed spending cuts, more taxes. Instead of significantly paring back the gargantuan public sector (yes, including welfare and the bureaucratic, inefficient NHS), the government chooses to heavily penalize middle and higher rate tax payers.

The increase in NI contributions means it will be more expensive to keep and hire workers. Hardly a sensible move when economic recovery is closely tied with job creation.

The pointless and harmful bonus super-tax will not generate revenues, but, just as the previously announced, vengeful 50% income tax, is sending the wrong message. Uncertainty – and the notion that everything is up for grabs – will make businesses and enterprising individuals think twice before coming to (or staying in) London.

The top 10% of earners already pay 54% of income tax and the top 1% pay 24%. But, no matter how much they are milked, it’s never enough for a socialist wealth redistribution agenda. From 2010 the UK will have one of the highest tax rates in the world. The state grabbing more than half of what the wealth- and job-creators make is certainly not a motivation to be ambitious and successful. And the paltry £500 million revenue is hardly worth the billions in investments and taxes the UK and the City of London is likely to lose as a consequence.

UK’s economic success depends on entrepreneurs, highly skilled workers, as well as a profitable financial services industry. Yet the signal the government is sending, by labeling such people as elitist & (bad) “rich” and imposing punitive taxation, is that the country neither values nor wants them here. And they may well listen, choosing a more welcoming destination for their efforts and money.