George Osborne speaks to Conservative Party Conference 2014. Photo: Gareth Milner
The ‘long-term plan’ is a political plan not an economic plan
Today the OBR released figures that showed, as widely expected, deficit reduction to date has stalled. Balancing the books (one further year into the future) relies on eye-watering and dangerous cuts in departmental spending. Meantime, in the economy, household debts have been revised up by £174 billion and UK’s relations with the rest of the world are further deteriorated.
No matter what the Chancellor says, this was not how it was meant to be.
On taking office, the government blamed its predecessor for blowing a hole in the government finances and castigated them for a severely unbalanced economy. A ‘long-term plan’ in the guise of austerity was devised to restore the economy; government profligacy shouldered the main blame for the economic malaise and bore the brunt of the attack.
Only two years later the long-term plan was failing in a big way. In their Autumn 2012 forecast, following widespread weaknesses in the data, the OBR downgraded significantly their forecasts. The government effectively abandoned its plan, as the ex-Chancellor Ken Clarke conceded last night, as he argued Britain would be in a “bad way” if the coalition had pushed ahead “full steam” with deficit reduction”.
Once more, unbalanced growth trumped no growth. The Bank of England was required to devise more expansionary monetary policies (‘forward guidance’). Various subsidies to banks were implemented so that households and firms would get borrowing again, not least funding for lending (further boosted today) and help to buy. These came on top of significant global stimulus from the ECB and Federal Reserve, it should be added.
The government can appeal to headline GDP and labour market figures until it is blue in the face, but the electorate don’t buy it.
For one there can be no genuine recovery when households continue to get poorer. The scale of the real earnings crisis is now familiar to one and all. The OBR have downgraded once more their real earnings forecast; in 2014 a rise of 0.3 per cent halves the 0.6 per cent expected at the Budget; in 2015, 0.8 replaces 1.2 per cent. On the basis of the RPI, real earnings remain negative in 2014 and 2015. More generally the OBR stress in para. 1.4 “the measure of real earnings in our forecast does not return to its pre-crisis level within the next five years”.
Moreover as incomes continue to fail to recover, household sector imbalances are re-emerging very quickly and substantially. The OBR (3.76) state: “Indeed, we estimate that the margin by which consumption growth will outstrip real wage growth in 2014 will be the second largest since the mid-1990s”. Households are back relying on reducing savings. And the OBR show massive increases in household debt, shown on the chart as a share of household disposable income.
Previously the peak in 2018 was reckoned to be lower than the pre crisis peak, now it has surged 15 percentage points higher. And at the peak, the UK household sector was one of the most indebted in the world. The OBR note that of a total revision to debt in 2019 of £174 billion, £84 follows updated estimates from the ONS; £49 billion comes from house price growth; and £41 billion from the growing gap between consumption and income. This last is a big number. We already know from debt charities the extent of the present pain, with one in six households relying on credit to see them through until payday. The resumed rises fostered by the government’s policies have already taken house prices to new levels of unaffordability, quickly alarming the Bank of England who may have succeeded in putting a lid temporarily on it (though the government fights back with stamp duty reductions).
Another resumed imbalance is in our economic relations with the rest of the world. As a percentage of GDP, the OBR have revised up the current account deficit by an average of 1 ½ per cent of GDP between 214 and 2018. The chart below shows the 2014 position is the worst on historical record, equal only to 1988 at the height of the Lawson boom.
Current account deficit, % of GDP
They note the relatively weak export performance (3.113). In fact, since the government took office, our export performance is third from bottom a league of OECD countries.
As a result of evaporating savings in the UK private sector, the cash equivalent of virtually all the government new borrowing is now met from overseas (chart 3.41). We see the ramifications from this in increased overseas ownership of our companies and residential properties.
Making similar observations, the Minutes for the November 2014 meeting of the Monetary Policy Committee stated: “the prospect of a continued reduction in private sector saving and a persistent current account deficit should be carefully monitored” (paragraph 18).
But it is in its own deficit reduction programme that the most blatant double-standards are apparent. We heard today a changed line from earlier in the week that deficit has been reduced by a half rather than a third; but the plan was by now (2014-15) to have reduced it by three quarters, as the following chart shows (not all historic figures are updated with revised versions as I can’t find them all yet, but I am sure the story is little changed):
Public sector net borrowing, £ billion
The cumulative shortfall is still around £100 billion.
Ahead of today’s speech the coalition were promoting the idea that the job is done, Cameron claiming “we’ve got the nations finances under control” on the BBC news at ten (Monday), and Alexander that any coming deficit reduction is ‘smallish’.
The OBR have implicitly decisively rejected this claim. Given the tax giveaways announced today, the vast shortfalls in revenues, the scale of spending cuts is absolutely eye watering. Three points the OBR make are worth citing:
- “Between 2009-10 and 2019-20, spending on public services, administration and grants by central government is projected to fall from 21.2 per cent to 12.6 per cent of GDP and from £5,650 to £3,880 per head in 2014-15 prices. Around 40 per cent of these cuts would have been delivered during this Parliament, with around 60 per cent to come during the next. The implied squeeze on local authority spending is similarly severe.” (para 1.7)
- “Between 2014-15 and 2019-20, … around 80 per cent of the remaining change in the budget balance (4.7 per cent of GDP or £86 billion in today’s terms) comes from the cuts in day-to-day spending on public services and administration implied by the Government’s firm 2015-16 plans, its assumption for total spending thereafter and our forecast for AME spending.” (para 1.34)
- “Relative to the size of the economy, nominal government consumption is forecast to fall from 20.2 per cent of GDP in 2013 to 14.7 per cent of GDP at the end of the forecast period, the lowest level on record in consistent national income data back to 1948 – and the lowest since 1938 using the Bank of England’s historical dataset (Chart 3.36)”.
Presumably the claims ahead of today’s statement were motivated by polls showing the public have had enough of austerity. Even today all the Chancellor had to say was
The work starts with our spending plans for 2015-16, which save £13.6 billion. We have published the detailed and specific departmental proposals that will achieve them. There will be two further years where decisions on this scale will be required. And as I’ve said before, we’re going to have to go on controlling spending after those years if we want to have a surplus and keep it.
It seems hard to square this with the OBR’s nearly exasperated interpretation of the scale of these cuts. Moreover the OBR are moved twice to warn about the economic dangers of these cuts.
the Government’s fiscal plans imply three successive years of cash reductions in government consumption of goods and services from 2016 onwards, the first since 1948. The corresponding real cuts directly reduce GDP. The economy should be able to adjust to such changes over time, but it is unlikely to be a simple process when monetary policy is already very loose and external demand subdued. (1.19)
While these assumptions are mutually consistent – private spending would be expected to rise as a share of GDP when the share of household income and corporate profits derived from government pay and procurement falls – they do illustrate the challenge facing the UK economy in adjusting to the further fiscal tightening that the Government is assuming.(1.26)
In reality the long-term plan is a political plan not an economic plan. The Chancellor’s was quick to abandon his original plan for austerity as the economy faltered in 2012. Fine words about imbalance were quickly forgotten.
But he today sets up the outcome as a success, and downplays in public the extent of imbalances that have already built up and the scale of the spending cuts that now must come (on the basis of the OBR’s views). In reality, the problems seem unchanged to those he confronted when he took office. He sets up a future agenda for cuts that must be suicidal. As Frances O’Grady said:
“All of this is the price of failure of the Chancellor’s strategy. He said that his policies would eliminate the deficit by next year. Instead we are now told it will be ten years. The worry must be that his policies will continue to fail and that austerity will become permanent with living standards continually depressed.”
Beyond the Government’s smoke and mirrors, there has to be another way between cuts and imbalance. This must involve a deliberate strategy that dismisses old dogmas. It must involve retreating from austerity, but with a plan to increase domestic investment, productivity activity, incomes and living standards. But that is for another day.