Two cheers for Alistair Darling’s admission this week that the next British government will have to “cut costs”, make “tough choices” and “live within [its] means” with “slower growth in public spending” — regardless of which party wins the election. Thanks to this belated admission of reality from the Chancellor, the country can now begin the serious debate on political priorities that Gordon Brown was justly ridiculed for trying to avoid before the summer holidays.

Mr Darling’s decision to defy his boss and break the Cabinet’s vow of silence on this issue could help Labour. If he could speak frankly and sensibly about the prospects for public spending, he might even be able to restore some of the economic credibility that Labour once enjoyed.

If, however, the Prime Minister tries to revert to his strategy of stubborn denial in the face of obvious fiscal problems, then he will forfeit whatever slim hope he might still have of re-election.

For the Tories, a serious debate on fiscal strategy that moves beyond sensationalised headlines about imminent national bankruptcy would create both opportunities and pitfalls. The opportunity for the Tories would be to demonstrate that they have a coherent strategy for managing public services. The pitfall would be revealing that they still have no understanding of public expectations in Britain, nor of macroeconomics.

To see why I emphasise the political ambiguities of this fiscal debate for both major parties, consider three distinct, though related, questions.

First, does Britain have a serious fiscal problem that calls for radical action? Until this week the Prime Minister and his acolytes replied “no” to this question. This was clearly wrong — or dishonest — and came close to destroying what was left of Labour’s economic reputation. With public borrowing suddenly exploding from 3 per cent of GDP to more than 12 per cent, and with the national debt burden expected to double between 2005 and 2014, British fiscal policy is unsustainable and something has to be done.

The second question is how soon the Government should attack the growing fiscal problem, given the depth of the recession and the global nature of the financial crisis. On this question, the Tories have been wrong, while Mr Brown has been mostly right. David Cameron and George Osborne were scathingly critical of the tax cuts and other stimulus measures introduced by the Government last autumn and now suggest that large tax increases and public spending cuts may be introduced immediately if the Tories are elected next May.

To tighten fiscal policy immediately beyond the measures already announced in the last Budget could be a big mistake on the part of the Tories, since the recovery that is now only just starting is unlikely to have developed a self-sustaining momentum by next May or June.

Indeed, every finance minister and central bank governor at last weekend’s G20 meeting agreed that 2010 would be too early to start reversing the macroeconomic stimulus programmes that have saved the global economy from a 1930s-style collapse. For the Tories to put themselves in a minority of one on this issue is perverse — not only because a major fiscal tightening next year could abort recovery, but also because there is almost no risk that investors will dump sterling or refuse to finance the British Government’s deficit at a time when other major economies are also running deficits that are almost as large.

It will only be when the global economy has convincingly recovered and other governments are cutting back their deficits that pressure in financial markets will build for Britain to move into line. In terms of timing, therefore, the Tories are over-hasty and the Chancellor, in Tuesday’s Cardiff speech, got it broadly right — major reductions in public borrowing should be planned now, but they should be implemented in 2011 and beyond, not next year.

The need for careful policy planning leads to the third and most important question: what measures should be taken to reduce deficits when the time comes? On this question neither the Government nor the Opposition has yet said anything convincing. While Labour has come up with nothing better than Mr Darling’s promises to increase efficiency and redirect spending to frontline services, the Tories have bandied around monstrous figures, suggesting that the country is on the brink of bankruptcy in the absence of a truly draconian fiscal tightening. This is not true, since a public debt of between 80 and 100 per cent of GDP projected for the middle of the next decade would not be unusual by historic or international standards and would impose a perfectly tolerable burden on future taxpayers.

With the Tories exaggerating the scale of the crisis, and Labour systematically underplaying it, there has not been enough serious thinking in either party about the relatively moderate reforms that could clean up Britain’s fiscal mess at reasonable political and economic cost.

The key to developing such policies is to distinguish between two separate causes of Britain’s fiscal problem — the depth of the recession and the public spending policies pursued by the Government in the past five years or so.

Most of the borrowing caused by the recession (and the reductions in income tax receipts and the extra unemployment payments) should eventually be naturally reversed, especially if Britain’s financial sector and housing markets recover more quickly than previously expected, which looks quite possible.

But there will be no such automatic reversal of the structural increase in the national share of public spending, the result of the Government maintaining the growth in public-sector employment and wages — even while the rest of the economy was dramatically shrinking.

It is this divergence between the fortunes of the public and private sectors, especially in the past 18 months when private sector earnings have collapsed, that is at the root of Britain’s long-term fiscal problems. Any government that wants to put Britain’s public finances back on a sustainable basis will have to focus on this rebalancing of jobs and wages between the government and the private sector — and that may mean reversing not just the increase in employment but reducing wages and pensions as well. This will be the real challenge for public policy in Britain in the first half of the next decade — and this challenge will have to be tackled, whichever party is in power.

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