Sometimes the real economic gamble is sometimes too little government borrowing – not too much

With his dad jokes and fetish for spreadsheets, Philip Hammond does not fit the stereotype of a “gambler”.

But the Institute for Fiscal Studies (IFS) nevertheless argues that the chancellor rolled the dice in last week’s Budget and took a rather risky wager.

Instead of using his lower borrowing projection “windfall” from the official independent forecaster to reduce the deficit more rapidly, Hammond essentially spent it all on the health service, while leaving the overall path of government borrowing more or less unchanged.

He could have had a projected budget surplus in five years’ time, but instead there’s still set to be around £20bn of borrowing in 2023-24.

Virtually the entire UK news media took up this “gambler” theme in their headline coverage of the aftermath of the Budget.

Yet we should be extremely wary of this framing. Because it obscures the crucial truth that, in economics, the gamble is sometimes borrowing too little, not too much.

The IFS, to be fair, was using the phrase in a narrow sense of the chancellor jeopardising his chances of meeting his own self-imposed fiscal rules.

Those Office for Budget Responsibility (OBR) borrowing downgrades – whose origins remain mysterious given the official forecaster hasn’t upgraded its nominal GDP or growth forecasts which would be the most obvious explanations for higher than expected tax receipts lately – could very well be reversed in future budgets.

Since 2010, most underlying borrowing revisions have been negative (implying more borrowing than previously expected) rather than positive for the public finances.

What the lord of forecasting (in this case OBR director Robert Chote) giveth, he can also taketh away. He even warned as much last week

And what would happen then? Would Mr Hammond really try to hike taxes while the government is walking the tightrope of a hung parliament? Would he cut public spending when the prime minister has told the country that austerity has ended? Isn’t it more likely that the result would be more borrowing? And what would happen to his fiscal rules then?

All this raises the question of whether or not the chancellor’s fiscal rules are sensible. If a man had resolved to jump off a building, we wouldn’t describe a decision to place obstacles between himself and the ledge as a “gamble” because it might mean him not achieving his suicidal goal.

Hammond’s rules, including a deficit below 2 per cent of GDP in 2020-21, are not suicidal. They are far less economically destructive than those of his predecessor George Osborne, who was insisting on running an absolute budget surplus in 2019-20, ignoring the advice of just about every independent public finance expert.

Yet there are other fiscal rules available. There is no reason to believe Hammond’s represents perfection. Indeed, it’s quite possible for a country to borrow indefinitely and still see the debt stock as a share of GDP decline provided (roughly) that the growth rate is higher than the deficit as a share of output.

Labour’s own fiscal rule targets a day-to-day budget surplus in five years’ time with a suspension if interest rates are still stuck close to zero, meaning monetary policy and the Bank of England cannot reliably help to boost growth if we go into recession.

That’s a perfectly reasonable rule, consistent with stable public finances, and one which requires less consolidation – and allows more near term borrowing – than the Chancellor’s.

And then there’s the state of the overall economy to consider.

The OBR judges that there is now no slack in the UK economy, suggesting any additional borrowing would be inflationary. But the OBR may well be wrong about that. Several other credible forecasters think there remains an output gap. Oxford Economics puts it at more than one per cent.

And even if we were to accept that the economy is running roughly at capacity, an output gap could easily open up again if we have a chaotic Brexit. At that stage additional public spending will be an economically stabilising influence, just as it was during the last recession.But the media’s wholesale adoption of the “gamble” framing from the IFS briefing, and the failure to put it in the specific context of the chancellor’s own chosen fiscal rules and the neglect of all questions of macroeconomic management, is evidence of what the Oxford professor and magisterial economics blogger Simon Wren-Lewis has rightly called “mediamacro”

A key element of mediamacro is the naive assumption that higher government borrowing is inherently dangerous and that lower borrowing is always praiseworthy.

This is a rule of thumb used by far too many political journalists, commentators, presenters, editors and producers. Some of them do it for ideological reasons, out of their desire for a smaller state and tax cuts. Some lazily accept the framing of politicians. But most ubiquitous and dangerous are those who consider themselves to be neutral and non-partisan yet still drift into looking at fiscal policy through this distorting prism.

It’s depressing and really rather shameful that after a decade of well-documented macroeconomic mistakes across the western world, it’s apparently still necessary to restate the truth that a national economy cannot be usefully compared to a household, and that the only kind of economic “gamble” some seem able to recognise is the one where the risk is more borrowing.

Hammond’s spring statement was no new dawn for the UK economy. It was an optical illusion

The bonanza, in the end, failed to materialise. There had been a fair amount of talk before the Spring Statement that Philip Hammond would be in a position to unveil a new dawn for our beleaguered public finances. City analysts had been chattering like South London parakeets about a potential £10bn permanent improvement in the public finances.

And the excitement had jumped the species barrier from the Square Mile to Westminster. The ardent Brexiteer Jacob Rees-Mogg had squawked about the imperative of ratcheting up spending on the struggling health service. Other Tory MPs had similarly chirruped in favour of a loosening of the Government’s austerity corset. The Chancellor himself had allowed himself to refer to “light at the end of the tunnel” in conversation with Robert Peston at the weekend.

Well the light of the tunnel may not quite have been the headlights of an oncoming train, but, according to the Office for Budget Responsibility, it was certainly an optical illusion.

The OBR did revise down its estimate of public borrowing in 2017-18 by around £5bn on the back of fuller than expected tax revenues so far this fiscal year. Yet Robert Chote and his team concluded that this was not likely to be a permanent improvement, mainly because they now estimate that the economy is overheated relative to their estimates in November. In other words, when things naturally cool down, the tax revenues will start undershooting. 

Similarly, the overall GDP growth forecast for the UK is a smidgen better this year. But next year – when Big Ben (may) ring out for Brexit– it is unchanged at a paltry 1.3 per cent. This, we should bear in mind, at a time when the rest of the world is growing at its strongest rate in years. And the expected UK growth rate is actually shaved down in the final years of the OBR’s forecast in 2021 and 2022. What the Spring Statement giveth, it also taketh away.

The Chancellor might have rebranded himself as Tigger, rather than Eeyore, but the OBR was channelling the lugubrious blue donkey when it concluded: “There seems little reason to change our view of [the UK’s] medium-term growth potential.

City scribblers earn their bread speculating about the short-term ups and downs of the economy and the public finances. But what really matters for our long-term living standards is the UK’s productivity growth potential, the amount of output we can collectively squeeze out of each hour worked and each worker. And the big picture is that productivity has been as flat as a pancake ever since the Great Recession a decade ago. Or at least that was true until the second half of last year, when we, surprisingly, witnessed the best two consecutive quarters of productivity growth since the financial crisis.

Yet the OBR doesn’t think the UK’s productivity growth engine has started roaring again, since the improvement in 2017 was driven by fewer hours being worked, rather than higher output. A similar surge happened in 2011 before petering out. Another broken promisein other words. Let’s hope they are wrong, but there’s not much reason to believe it, particularly given ongoing public spending cuts and Brexit continue to dampen the animal spirits of households and companies.

And what of that pachyderm in the living room? What about Brexit? The consensus of serious economists is, of course, that Brexit will harm our growth potential by throwing up trade obstacles between us and ourbiggest commercial partners and, probably, reducing useful immigration to boot. And the OBR is not demurring from that. Its view, articulated way back in 2016, that Brexit would damage the UK’s public finances, wiping out any “dividend” from not making annual contributions to the EU Budget, still stands. And that’s based on the assumption the Brexit process is nice and smooth.

In the short-term, the OBR, conceded the economy had held up better than it expected immediately after the plebiscite. But this was partly due to the unexpected global growth spurt, partly because households seem to have dipped into their savings to support their spending. Moreover, as the OBR stressed today, it simply doesn’t regard the Office for National Statistics’ estimates of how the economy performed since the vote as reliable.

In short: as you were. The new Brexit dawn for the British economy looks remarkably like the old one.

Here’s what to look out for in Philip Hammond’s Budget this week – and how to tell if the Government is serious or not

At 12.30pm on Wednesday Philip Hammond will step up to the House of Commons despatch box and deliver the UK’s first Autumn Budget. The long tradition of the Spring Budget will thus come to an end. But some of Hammond’s colleagues in the Conservative Party are warning that it could be the end of the road for him as Chancellor too.

Hardline Tory Brexiteers, affronted by Hammond’s cautious approach to leaving the European Union, are pushing for him to be replaced with an enthusiast for the project. And then there is the competence factor. A national insurance increase for the self-employed in the March Budget was withdrawn on Downing Street’s orders within weeks, in an epic humiliation for Hammond. If this Budget similarly unravels it is hard to see how he could carry on.

The overall economy is slowing as higher inflation bites into household wages, which are still growing only feebly, and as businesses sit on their hands rather than invest due to the uncertainty created as Brexit approaches in 2019. That context inevitably limits Hammond’s room for manoeuvre against his self-imposed fiscal rules.

Yet the political bomb that went off at the June general election, robbing the Conservatives of their expected majority, has scrambled politics and created huge pressure for more spending. Even many Conservatives are calling for the Chancellor to ease austerity in order to take the wind out of the sails of the Labour Party under Jeremy Corbyn.

So the personal stakes are high, the economic outlook is uncertain and the political scene is unusually fluid. So what are the big issues to look out for on Wednesday? How is Hammond likely to approach them? And what numbers should we pay particular attention to?

Housing

Ministers have been talking up their plans for a large expansion of house building to address what they now accept is a UK “housing crisis”. The Communities Secretary Sajid Javid has been lobbying for a substantial increase in public borrowing to deliver more homes and promised last week that the Budget will show “just how seriously we take this challenge”.

The Treasury has flown a kite of a stamp duty cut for first-time homebuyers. But what really matters is how much state money will be put into supporting housing construction, after the relatively modest sums announced during the Tory party conference in October were widely dismissed as inadequate. Housing associations will be looking for significantly more grant money to enable them to build more social housing for rent.

Local authorities seem likely to win permission to borrow to start the construction of council housing again after it effectively ground to a halt in the 1980s. But keep an eye on how much additional council borrowing will be projected by the Office for Budget Responsibility to gauge how significant this loosening – and therefore housing delivery by local authorities – is expected to be.

Public sector pay

The Conservatives’ 1 per cent cap on public sector pay has already been lifted for prison officers and police. But the pressure to ease it for teachers, nurses and other public servants is now intense, especially with multiple warnings over recruitment.

Yet lifting the cap will not be cheap. The Institute for Fiscal Studies calculates that allowing wages to grow in line with inflation would cost around £6bn extra by 2019-20. The unions are demanding even more – a 4 per cent rise. If the Conservatives do relax the cap substantially this will have an immediately obvious impact on the public borrowing projections.

Young people

Labour enjoys a huge polling lead among the under-40s, largely thanks to Jeremy Corbyn’s striking promise to abolish tuition fees and ambition to “deal with” their debt burden. In response, the Government has already made the tuition fees system more generous. And there have been some suggestions that the Chancellor in the Budget might cut national insurance contributions for younger workers, financing it by restricting pension tax relief for older workers. But the big question is whether such incremental reforms will draw attention away from Labour’s simple, eye-catching, offer to the young?

Welfare cuts

Cuts to working-age welfare and universal credit put in place by the previous Chancellor George Osborne were set to bite over the coming years, and are projected to push up inequality and poverty. There have been signals the Chancellor will cut the contentious six weeks that recipients of universal credit must wait. This will cost some money, but the bigger question is whether Hammond will defray the overall package of cuts.

A key number to look out for is whether the £12bn of savings projected to come from the welfare budget over the next five years actually comes down or not on Wednesday.

Infrastructure investment

As well as talking up house building, ministers have been stressing their commitment to more infrastructure investment to help solve the UK’s productivity crisis. There will almost certainly be plenty of talk about this in the Budget – there always is.

But how should we judge the substance? In the March Budget public sector net investment was pencilled in to creep up from around 2 per cent today to 2.3 per cent in 2021-2022. Labour’s manifesto, by contrast, pledged to take it up to 3 per cent of GDP. Will the Conservatives match Labour?

Fiscal policy

The Chancellor’s fiscal rule requires him to run a structural deficit of no more than 2 per cent of GDP in 2020-21. In March he had around £26bn of headroom against this target. Public borrowing has been rather lower than expected so far this fiscal year, but the OBR has said it plans to slash its productivity forecasts on Wednesday, which will probably have the effect of wiping out some of this fiscal improvement over the medium term. The big-picture macroeconomic question for the Chancellor is whether he scraps or modifies his 2 per cent target in order to spend and borrow more on all the areas discussed above – and also on the NHS and education.

There is a strong economic argument that doing this would actually help support overall GDP growth at a time of weak private-sector demand and growing Brexit headwinds. When Labour has argued for such a relaxation of spending cuts in the past the Government has always batted it away with the claim that the bond markets would panic if they deviated from the fiscal plan. Yet it’s notable that even some professional investors in UK Government debt are now urging the Chancellor to increase borrowing to spend on infrastructure.

This article was originally published in The Independent on 20/11/17

Britain is are still deep in the winter of austerity – and Brexit is only making it worse

We are still deep in the winter of austerity. The latest Green Budget from the Institute for Fiscal Studies makes that icily clear. Philip Hammond may have dropped George Osborne's economically reckless target of eradicating the deficit in its entirety by 2019-20, but he didn't reverse any of the spending cuts baked in by his predecessor in the wake of the last election. The freeze on welfare payments will bite all the harder as inflation spikes due to the plunge in the pound since the Brexit vote.

Departmental spending budgets are also set to carry on falling. Taxes overall are on the up too, despite the Conservatives' "tax lock" on income tax and VAT, mainly thanks to a plethora of stealth tax rises such as hikes in the levy on dividend payments and insurance contracts.

The IFS calculates that there will be around £60bn worth of austerity by 2019-20. Of this £12bn (20 per cent) will be raised from cuts to welfare. Some £16bn (25 per cent) will come from tax rises. But almost all the rest - by far the biggest chunk of austerity - will come from slashing spending by Whitehall departments.

By the end of the Parliament the budgets of departments such as justice, business, culture and the environment will be an astonishing 40 per cent lower than they were in 2010, when the programme of cuts began. And even then the pain will not be over. If the Budget, due to be delivered on 8 March, is to be finally brought into balance during the next Parliament the IFS estimates this will require another £34bn of austerity.

Needless to say, none of this is good news. The welfare cuts will pummel the incomes of some of the most financially vulnerable households in the country, and almost certainly push up inequality in the process.

Cuts on this scale to Whitehall departments are inevitably going to erode the quality of public services; some will probably be stretched beyond breaking point. Stealth tax increases will inevitably be passed on to households, squeezing disposable income.

What is going on? Why are on earth are we still knee-deep in austerity almost 10 years after the financial crisis hit? There are two main answers.

The first is that the UK population is ageing. This, naturally, means that the pensions bill is automatically increasing every year. But the situation is exacerbated by the fact that pensions - easily the biggest element of the welfare budget - have been protected in real terms by the Government since 2010.

The ageing population has also put great pressure on the National Health Service since older people tend to consume more health care. NHS spending, the biggest tranche of departmental spending, has also been protected in real terms since 2010 by ministers (although as the chaos in hospitals reminds us, spending is still falling badly short of rising demand). Protected pensions means welfare cuts have been pushed on to working age benefit recipients. And the protected NHS means most other government departments have had to shoulder the lion's share of the cuts.

A bird's-eye view of the public finances shows that taxes are rising as a share of GDP to their highest level since the late 1980s (37 per cent). Yet public spending is set to fall to only its lowest share of GDP since 2003-04 (38 per cent). The latter statistic has prompted some on the right to scoff at the whole concept of austerity. 

"Was public spending really so inadequate in 2004?" they ask. But this is, intentionally or not, badly misleading. The reason for the discrepancy between the bird's eye view and the pain on the ground is that we're being forced to spend more on an older population, which is squeezing down the resources available for just about everything else.

The second main reason we are still in a world of austerity is that the size of the economy is so much smaller than we thought it would be seven years ago. Productivity growth - output per hour - has stalled since the financial crisis, which inevitably translates into weaker GDP growth and a lower tax take.

We still do not understand why productivity has stalled and it's a phenomenon that can be seen across the Western world. But in Britain's case, it's pretty clear that George Osborne's severe cuts to government infrastructure spending between 2010 and 2012 did unnecessary damage to growth. Now we have Brexit to contend with.

By diminishing Britain's long-term potential productivity growth (an outcome the vast majority of economists expect) leaving the European Union will only make this problem worse. The national economic pie will be smaller and a larger share of it will be eaten by older Britons - the majority of whom, incidentally, voted for and delivered the Brexit vote. They may have "taken back control", but the bill will largely be picked up by the young.