Avoiding another 1992
First reaction to the Autumn Statement and Office for Budget Responsibility report
The chancellor’s Autumn Statement contained an assortment of measures aimed at boosting growth. However, the independent Office for Budget Responsibility does not believe they will have a significant effect. The OBR’s forecasts for the economy and for the UK’s public finances make grim reading. On these projections, austerity will still be under way after the general election with further cuts in spending required to meet the fiscal targets. The figures out today show the government’s economic policy is in tatters. Yet there is still a challenge for Labour.
The government’s pre-statement softening-up exercise suggested that problems in Europe would be behind cuts to the OBR forecasts and a more difficult fiscal situation. In fact, the OBR states that it missed its forecasts for the economy to date primarily because inflation was higher than expected. Household consumption met forecasts but in real terms was down. That may have led to businesses investing less than expected. Moreover, the new forecasts have revised down GDP growth mainly because the OBR believes that productivity growth was more severely hit in the downturn than it had previously assumed. That means the output gap – the spare capacity which can be filled relatively easily by faster growth – is now believed to be 2.5 per cent of GDP rather than 4.7 per cent. The upshot is that it won’t take that much for the economy to be at full capacity and therefore more output was lost in the recession than we had believed. This is consistent with data from past financial crises but the reasons are not fully understood. It contrasts with conclusions elsewhere that the fundamental problem is lack of demand (the economy needs higher demand but the OBR suggests the ability to meet higher demand has been hit). The OBR also now assumes the economy will take longer to reach its trend rate of growth.
The new forecast means that not only will borrowing be higher, with net debt peaking at 78 per cent of GDP rather than 70 per cent, but that the structural deficit will be higher too. The structural deficit is that element of borrowing that will not simply go down as an upturn in the economic cycle kicks in. The change in this projection is linked to the belief that the output gap is smaller. Not only is borrowing up, but more of it is permanent unless reduced by permanent spending cuts or tax rises. The government would have been on course to miss its fiscal targets if it had not planned new tightening in later years.
This represents a failure by the government because a more pro-growth policy 18 months ago might have led to a different outcome. However, it represents a challenge to Labour because it suggests that growth policies would have to be aimed at boosting the economy’s productive potential and not simply encouraging households to spend a bit more.
The higher borrowing might suggest too that you can have higher deficits without raising the cost of government borrowing (ie gilt yields are lower now than a year ago). However, as I have argued elsewhere, the point is that markets must believe governments are serious about getting borrowing down and not conclude they are reluctant to control it. They have to be credible. That is where Labour must continue to work on its economic policy.
Forecasts can change and even the OBR believes there is only a 60 per cent probability the government will meet its targets. A period of growth might lead to new estimates of the output gap and structural deficit. The OBR does run a scenario where more borrowing turns out to be cyclical: growth would be much higher and the targets easily met. It also looks at what might happen if tight credit conditions persist: the targets are missed.
In such circumstances as these, what should we expect from government? Well, we should look for a strong drive on growth, to raise the productive potential of the economy and get people into work. Instead we saw small measures, hardly amounting to a bazooka of the sort David Cameron likes to recommend to struggling eurozone countries. George Osborne had already announced a national loan guarantee of up to £20bn of small business loans (the Institute for Fiscal Studies calls this ‘more of an ambition than a done deal’). The arrangement has some echoes of the way KfW, the German investment bank, operates. Yet what is stopping the coalition going all the way and establishing a national investment bank? For that matter, what is stopping the Labour party from recommending it (we are committed to looking at the idea)? Major institutional change is required to change the economic mindset and to convince businesses that government is permanently committed to raising productivity. As the new measures stand, they may lower interest rates to SMEs but there is no guarantee they will increase the supply of credit, which is what is needed. Measures to partially reverse Labour’s Future Jobs Fund should be welcomed, but the OBR now forecasts unemployment to rise to 8.7 per cent, from the current 8.3 per cent. It has also raised its forecast of public sector jobs lost by around 300,000 to over 700,000. A much more aggressive pro-employment policy is needed. Other measures announced, which appear to hit the poorest hardest (eg some benefit cuts, raising the retirement age earlier than previously planned), only emphasise this need. The Institute for Fiscal Studies is talking about a period of over a decade, from 2002-3, in which real median household incomes will not have risen.
How should Labour respond? If we believe these forecasts, and we should note that the OBR believes the risks are on the downside for growth, we need to be much more focused on what progressive policies should look like in more austere times. Each shadow minister and policy forum member needs to be taking a hard look at this. Apparently some Tories believe the next election will be similar to 1992, when John Major won against expectations because he was more trusted on the economy than Labour. Much could change over the next few years but the lesson Labour learnt was that it had to be credible on the economy – credible to markets and the electorate. Let us learn that lesson again and work hard to be credible on deficits and on growth now.
This article was first published by Progress on 30 November 2011.
For more information about my Fabian Society pamphlet The Credibility Deficit - how to rebuild Labour's economic reputation, click here.
Progress, 30 November 2011, 05/12/2011