The LibCons / ConDems had their “independent Bank of England” moment yesterday.
The Office for Budget Responsibility (OBR) is tasked with predicting the future of the British economy. The difference is, its crystal ball is meant to be free from political interference.
The idea is that the OBR – even although it’ll still get things wrong – will at least have no temptation to polish up the numbers to give the party (or parties) in power a boost.
So what did its first report tell us – and what does it mean for you?
The long-term outlook for Britain is worse than expected
Let’s cut to the chase. The OBR said that the short-term outlook for Britain was a bit better than expected. But the long-term outlook is worse.
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Why’s that? Well, our debts are still staggeringly high. But overall government borrowing is going to be a bit lower over the coming five years than the Labour government had forecast. That’s because tax receipts look like they’ll be healthier than expected.
That’s good. Indeed, there have been suggestions in the press that Alistair Darling deliberately over-egged the pessimism on this score to stop Gordon Brown from going on a pre-election spending spree. My gut instinct has always been that Darling is a pretty decent guy by the standards of his profession. If this is true, then good on him for putting the country’s welfare ahead of cheap votes.
The bad news is that this doesn’t mean that David Cameron and co will scrap all their talk of cuts. That’s because the structural deficit is worse than previously thought. Let me explain that for a moment. The deficit is the gap between what the government gets in taxes and what it spends in a year. Now you might expect the government to overspend during hard times. That’s because taxes fall and benefit payouts rise. That’s understandable.
But the structural deficit is any overspend that remains even when the economy is running at its normal growth rate. So even when tax receipts recover, and unemployment falls, you’re still overspending. That’s unsustainable. At some point, the national debt will reach a tipping point where no one is willing to fund your profligacy any more, particularly if you’re reliant on foreign investors rather than a captive domestic audience.
Why the gap? Because the OBR has concluded that the last government’s expectations for economic growth were too upbeat. The OBR reckons the UK economy will grow at a rate of 2.6% next year. That compares to the 3.25% pencilled in by Mr Darling. And our long-term growth rate could be as low as 2.25% a year – far weaker than the 2.75% assumed by Gordon Brown.
So the hatchet hanging over the economy remains in place. This won’t make George Osborne soften his plans for the Emergency Budget next Tuesday.
What will public spending cuts do to the economy?
But won’t cutting public spending ravage the economy? “I am now 100% certain that these actions will push us into double-dip recession,” piped up Danny Blanchflower, the ‘rogue’ former Monetary Policy Committee member, in his column for The Mirror the other day. And even Sir Alan Budd, in the OBR report, warns that it’s uncertain as to whether or not “private sector spending and employment are able to fill the gap that the cuts in public spending… leave”.
But Jeremy Warner in The Telegraph this morning makes a very good point on this matter. “To me, the debate already seems stale and irrelevant, for it assumes that the country has any choice in the matter.” The fact is that Britain now has to cut back whether it likes it or not. Other economies such as Greece and Portugal – and even Germany now – are trimming their deficits. If Britain doesn’t follow suit, it’ll be targeted by investors worrying about sovereign debt crises.
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And in fact, says Warner, it should be “perfectly possible to have reasonable growth alongside fairly dramatic rates of deficit reduction. It’s been done twice before in Britain in the last 30 years,” in the early ’80s and in the mid-’90s.
This may be optimistic. We think there’s a good chance that Britain will suffer a double-dip recession. But it won’t be because public spending cuts are wrong-headed. Part of the problem is that Europe is looking weaker by the day (because of government over-spending). The eurozone accounts for roughly 60% of UK trade. So if they’re not buying anything, then it’s going to hurt us. Meanwhile our own consumers are still hugely indebted, and surviving mainly due to very forgiving interest rates and a banking sector that’s being propped up by the Bank of England.
Shrinking the government’s role in the economy is a good idea
But shrinking the government’s role in the economy will help rather than hinder. The trouble is that when government spending becomes a large part of the economy, you increase instability and uncertainty. Money does not flow to projects on the basis of which ones will generate profits. It flows to areas based largely on arbitrary shifts in ideology and cronyism. The economy becomes more about who you know, than about what you know.
In those circumstances, people save money. They hoard capital when they get it, because they don’t know what the rules of the game are anymore. You only have to look at the state of Japan to see what happens when government spending becomes the economy’s main life support mechanism. Or if you want to see what happens when a company becomes politicised, you just need to look at BP.
Of course, that doesn’t mean the government won’t mess this up. It may go for easy targets in the cuts, rather than targeting the areas where the state really shouldn’t be involved in the first place. Or it may put the emphasis on tax hikes that hinder private sector growth. We’ll soon find out.
We’ll have more on the outlook for the British economy – and why we think a double-dip is very likely – in this week’s issue of MoneyWeek magazine, out on Friday. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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