Tory plans are simply unrealistic and political
The annual autumn statement this Wednesday is not just about the economy, it is very much a political event. Reports that George Osborne plans to introduce a law requiring the government to balance the budget by the middle of the next parliament illustrate that well. There is no economic justification for this. It is a political move designed to put Labour in a difficult place. Politically, the statement will be designed to box Labour in ahead of the general election next year.
Investors will be scrutinising the chancellor of the exchequer’s words and, more importantly, the accompanying report from the Office for Budget Responsibility. The economy has been growing at a fair pace, as new GDP data confirmed this week. The revised GDP data for the third quarter also raise some questions about sustainability of the recovery. Most of the 0.7 per cent growth in Q3 was due to current and capital spending by the government. While government investment spending rose, business investment fell 0.7 per cent. It is too soon to say if that will alter the upward trend in private sector investment. Projections by both the Office for Budget Responsibility and the Bank of England assume a significant contribution to growth from this area. We also know from Bank of England agents reports that there has been some reduction of activity from the beginning of the current quarter and a dent in the confidence of some businesses, particularly those focused on export markets. Markit/CIPS purchasing manager indices out this week may shed more light on current conditions.
Despite the growth, tax receipts, particularly from income, have not grown in line, and if growth weakens the disparity could grow. That presents a threat to the OBR’s forecasts of future budget deficits. The OBR was too pessimistic in its growth forecasts for this year and may revise forecasts higher, but tax receipts have still disappointed. Under Osborne’s original plan, the structural deficit was supposed to have been eliminated by the election. We are nowhere near that. If the OBR becomes more pessimistic, the scale of the challenge will be much larger. Despite this, the Conservatives, with Liberal Democrat support, apparently want to introduce a law to require elimination of the deficit by 2017-18. Plans to achieve an overall budget surplus by 2018-19 imply a total of £48bn spending cuts (or tax rises) in the next parliament. Within that figure, the next spending review will have to find £37bn, according to the Resolution Foundation, of which £25bn will be spending cuts after welfare support is cut by £12bn. With some departments likely to be protected, that implies steep cuts in other areas. In addition, the Conservatives plan tax cuts of £7bn and have announced an alleged extra £2bn for the NHS.
The scale is such that we have to ask ourselves: are we really sure the conventional wisdom about deficits is correct? As the Office for National Statistics noted recently, ‘debt is important because investors have to be persuaded to finance it’. This is true and no government should ignore it, nor can it for long. However, in case no one in politics has noticed, the government can at the moment borrow for 10 years at a cost of less than two per cent a year. That is with a government on course to miss its original debt target by over £100bn. Even taking into account the Conservatives’ desire to seize the opportunity to reduce the role of the state, it is extremely unlikely the next government will meet these deficit targets, unless taxes are also raised. But some targets are necessary. Investors in government bonds need to know that borrowing will be credibly kept under control and that the government means business. They also need to be confident there will be sufficient economic growth to deliver the necessary tax receipts. Targets that are too tight will be seen as unrealistic and political, which is what Conservative plans now amount to. That can damage market confidence, particularly if the scale of spending cuts is not appreciated by the general public. For now, the Conservatives’ intent is not being seriously challenged, a situation that may not last.
Labour’s plan to reduce the non-cyclical part of the current deficit by 2020 is more realistic but still implies spending cuts. To gain credibility for its own deficit-cutting plan, Labour needs to show it means business when it comes to controlling spending. The zero-based spending review is an important part of this exercise. But we can afford to be bolder on the economy when it comes to growth. Indeed, we have to be on the attack because otherwise we will be caught in a battle about how much spending to cut. In such a regressive battle, the Conservatives will always be prepared to outbid us on the size of spending cuts, regardless of their inability to deliver them if elected.
This article was first published by Progress on 1 December 2014.