From the TUC

The Economics of the CSR & 2015

30 May 2013, by Guest in Economics

I’ve written before that I find the current political debate ahead of the spending review somewhat confusing.

The Government, and many of their supporters in the media, now appear to think that the way to gain “economic credibility” is to commit to a fiscal plan that has failed to achieve growth, deal with the deficit or even retain the UK’s AAA rating.  The argument can be summarised as, “our plan has failed to achieve any of its goals and opposition parties will only be seen as credible if they agree to stick with it”.

As I say, I find the logic underlying this perplexing.

In many ways it reminds me of the Chancellor’s argument after the UK was downgraded, which boiled down to “the fact that we have been downgraded proves that my plan to avoid downgrade must be stuck to”.

I’ve argued before, at tedious length, that the real debate ahead of the coming CSR should not be whether political parties sign up to it but instead what the UK’s fiscal framework should look like.

In effect the current fiscal framework is to eliminate the structural deficit in a rolling five year period that never actually bites.

In many ways this is the worst of all worlds, the short period of the target forces the government into making cuts too quickly which damage growth but the fact that the policy is so-flexible means the tomorrow never actually comes and so the period of cuts are continually extended. This is a recipe for continual austerity.

But the problems with the current framework don’t stop here. I would go further and argue that the structural deficit itself is the wrong target. The structural deficit is not something that can be measured, it is only something that can be estimated and those estimates are highly uncertain.

I’ve also argued before that a more appropriate framework for the UK would focus on reducing debt/GDP over a much longer timetable.

Despite having a larger deficit than, say Canada or France, the UK needs to issue less gross debt each year than either. Whilst the UK may come towards the top of the table for size of deficit, it is very much in the middle of the pack when it comes to gross issuance. This is directly down to the long maturity profile of its debt.

As Fitch note (this really is worth quoting twice!), together with low interest rates this “implies a higher level of debt tolerance than many high-grade peers”. To simplify, the UK economy is better able to handle periods of higher debt/GDP than other countries.

All of which suggests that the UK has room for a much slower fiscal adjustment than it is currently pursuing. This yet another reason to seriously question the UK’s current (failed) fiscal framework.

Gavin Kelly, earlier this month, made a strong case that much of the current political debate around the CSR is missing the point. As he notes the planned spending review will only covered the period until 2015/16 – i.e. it will end in April 2016.

Sure, at the margins it will be possible to do some mid-year shuffling of resources between departments, or to top up some priority budgets that are capable of being quickly spent. The coalition made a few mid-year cuts in its first year and Labour could try to make its own modest adjustments. If the civil service is taking the prospect of a Labour government seriously then perhaps progress on a top priority such as the proposed job guarantee might get under way during late 2015. But the far bigger truth is that any real shift in spending would wait until April 2016.

The more I think about it though, the more I think an even bigger point is being missed in the current debate around the politics of the CSR. On most forecasts the economy is still likely to be depressed in 2015/16 and indeed 2016/17.

The crucial number to examine here is the output gap – and in particular the OBR’s own assessment of it.

Simply put, the output gap is a measure of how much spare capacity there is in the economy. If the output gap is negative then the economy is operating below capacity and there is a strong case for expanding demand to make good the difference While if the output gap is positive then the economy is operating above trend and may be overheating with consequences for inflation.

Back at in June 2010 the OBR forecast that by 2015 the output gap would be -0.9% of GDP, i.e. the economy would be operating a below potential but not by a huge amount.

The current OBR forecast is for an output gap to be -3.4% in 2015 and still at -2.9% in 2016. In other words, come April 2016 (the time when any new government can actually make spending decisions in a meaningful manner) the economy is still expected to have an output gap of almost three per cent . The OBR’s own forecasts imply that there is room for a fiscal expansion of almost three per cent of GDP in 2016/17.

Recent work from NIESR, funded by the TUC, found that in ‘crisis times’ (when output is depressed – i.e. a -2.9% output gap implies ‘crisis times’) then a capital spending intensive stimulus of 2% of GDP will boost growth, lower unemployment and lead to a lower debt/GDP ratio in the medium term.

Much of the current politics around the CSR feels, for want of a better phrase, “very 2010”. The assumption in much of the political (if not the economic) coverage of the CSR seems that by 2015 macroeconomics will not really matter. The economy will broadly have recovered and the task of the Treasury will the essentially distributional job of managing cuts in public spending and tax rises to close the deficit, rather than actively managing demand and boosting growth.

This is looking like an increasing optimistic view.

GDP is expected to reach its 2008 level at some point in 2014. By this measure then we could argue that the economy will have ‘recovered’ within 18 months.

But GDP per capita (which accounts for population change) is not expected to reach its 2008 level until 2017. So by this measure, which is more reflective of most people’ s experience than headline GDP, ‘recovery’ is still some four years away.

But even GDP per capita is a poor measure of most people’s experience – it is a mean rather than median and so is distorted by inequality, a huge increase in the income of the top 1% could boost GDP per capita whilst living standards continued to flat-line for everyone else.

If we look at median real wages then we won’t be back (on current forecasts) to 2008 levels until the early 2020s. ‘Recovery’ measured through median real wages is a decade away.

The economy in 2015 and 2016 is likely to remain, by any reasonable standard, depressed. The case for a new fiscal framework, which gives governments the room to borrow to boost growth in the short term, will remain strong.

As we learned in 2010, macroeconomic policy choices matter.

UPDATE: To put this all really simply, we shouldn’t be so concerned about the ‘deficit deniers’, it’s the ‘depression deniers’  we need to worry about.

One Response to The Economics of the CSR & 2015

  1. justin thyme
    May 31st 2013, 8:16 am

    Don’t worry, the population will be much smaller soon.

    After this lot, most disabled and poor people will be dead

    Social Fund – abolished.
    Crisis Loans – abolished.
    Independent Living Fund – abolished.
    Severe Disablement Allowance – abolished.
    Incapacity Benefit – being converted to ESA,
    Disability Living Allowance – being converted to PIP.
    ESA for long-term sick – sanctionable subject to jobsearch.
    JSA – sanctionable up to three years.
    Workfare – up to 6 months for JSA claimants.
    Workfare – indefinite for ESA WRAG claimants.
    Tax Credits – tougher eligibility rules.
    Council Tax – part payable by all claimants.
    Bedroom Tax – payable by anyone with “spare” room.
    Legal Aid – removed for benefit cases.
    Rationing of aids – 3 nappies a day for incontinent disabled children.
    Cuts in care provided by LAs for the same cost to the claimant.
    All this in just the past two years – plus a 20% rise in familial homelessness and a 40% rise in street homelessness in London.
    Families moved to B&Bs, Premier Inns, etc. and landlords refusing to take benefit claimants, evicting them on an unprecedented scale.
    If Universal Credit ever comes in, there will be a whole new cohort of people (about 3 million) subject to the same conditions as JSA and ESA claimants are now, irrespective of how many hours they work.
    Average waits for benefit processing – 4 weeks JSA, 6 weeks ESA, 3 months DLA. No Crisis Loans available, so people have to rely on food banks – and hope that their landlords and utility providers will wait.
    Meanwhile, IDS gets censured by the ONS for lying with statistics, and his department decides to delay publication of the workfare figures – then, he offers to cut another 3 billion from his budget so that other spending can be saved from Osborne’s axe.
    The DWP is now referring people to food banks as a matter of policy

    The safety net (welfare for all) has gone now