IN MAJOR fiscal consolidations, what gets done in the first two years is what gets done – unless or until there is another crisis. More than two years into the coalition’s deficit reduction programme, George Osborne now finds himself unable to change his strategy through additional tax rises or spending cuts.
He spent those first two years raising taxes, cutting capital spending according to his predecessor Alistair Darling’s plan, and scheduling (though not implementing) his own large cuts to current spending. Unless or until there is a gilts strike, an economic crisis like the euro collapsing or an oil price spike, a General Election or the replacement of one or both of the Labour and Conservative leaders, the best we can hope for is that Osborne will implement the spending cuts he’s already planned.
There was therefore no surprise that the Autumn Statement proceeded on a “not a penny more, not a penny less” basis of fiscal neutrality, despite the worsening growth outlook. The most encouraging aspect was that Osborne confessed straightforwardly that he will not meet one of his fiscal targets – that debt should be falling as a percentage of GDP by the end of the Parliament. That was a refreshing contrast to last year’s Autumn Statement. Back then, he damaged his credibility by abandoning the plan of eliminating the structural current deficit over the Parliament, but pretended that had never actually been the target.
Osborne argued that, since meeting his target would have required an additional £17bn in spending cuts or tax rises, trying to do so would be a bad idea. I disagree, but I understand. To achieve £17bn of additional cuts to public spending, he would have to take the ring-fence off health and schools spending, and that’s not likely to be a political go-er until there is a crisis.
Given the fiscal picture was never going to change, the most interesting feature of the Autumn Statement was the Economic and Fiscal Outlook the Office for Budget Responsibility (OBR) publishes alongside it – particularly its forecasts for the underlying growth rate of the economy.
In my view, the key macroeconomic issue since 2009 has been whether the UK would grow fast enough over the medium-term that, without high inflation, salaries would rise sufficiently to allow families to pay their mortgages. Without medium-term growth, unless there is inflation, there will be widespread mortgage defaults and the UK banks will go bust again. And the most important thing the government could do to boost medium-term growth was to cut government current spending.
Back in 2010, the OBR thought that the underlying growth rate would quickly revert to 2.3 per cent per year – not far below the figures the Treasury believed before the crisis. I said 1 to 1.5 per cent was more plausible. In November 2011, the OBR pushed back its view of when potential output growth would accelerate, accepting a rate of around 1 per cent for the period from 2008 onwards, but still claimed output would rise by 2.3 per cent in 2014. In yesterday’s analysis, the OBR has again downgraded its view of potential output growth to just 0.5 per cent in 2012, 1.7 per cent in 2013, and not reaching 2.2 per cent until 2016. Even now, the OBR figures are optimistic. As well as continuing to be higher than our estimates, they are also higher than the forecasts from the International Monetary Fund, the OECD and the European Commission.
The OBR identifies the risk that potential output does not grow as rapidly as it hopes as the single biggest risk to the government managing to eliminate the structural current deficit by its (now greatly-extended) 2017-18 deadline. And if potential output growth is low, but Britain’s relentless stimulus policy – through massive government deficits, ultra-low interest rates and quantitative easing – does manage to generate some reasonably rapid growth (as it may), the consequence will be inflation.
Such inflation will be attractive in one way for the chancellor. In this Autumn Statement, he decoupled rises in so many benefits and tax thresholds from the inflation rate, so high inflation will generate him extra revenue and cut benefits in real terms. But if inflation edges higher, Osborne will not be able to blame the Eurozone or Gordon Brown. He will own that disaster all by himself.
Andrew Lilico is chairman of Europe Economics.