The UK must continue with its plans for deficit reduction. Easing the fiscal pain now would provide little or no benefit
One thing is clear after Chancellor George Osborne’s Autumn Statement – austerity is the new normal. Recovering from the global financial crisis was always going to be hard. History shows that crises that begin in financial sectors tend to be severe and prolonged.
Further, given the large increases in public and private debt in the years before 2008, the UK went into the crisis in a vulnerable position. The ‘borrow now, pay later’ culture was always going to end with belt tightening.
Given the scale and nature of the loss of output, the economy will take its time to return to pre-recession levels of gross domestic product. As Reform argued in June 2010, the rescue of the public finances will not happen in one term of a Parliament. Even under the best economic scenario, austerity should be at least a two-term project with the first term emphasising deficit reduction and the second consolidating the gains.
This does not mean that the UK necessarily faces a ‘lost decade,’ in the phrase of Christine Lagarde, managing director of the International Monetary Fund. By playing its cards right, the UK could create a stronger and fairer economy.
But this will require being clear on where government can add value, and where it can not. After all, real growth will come from a dynamic, highly productive economy, not from government. Playing these cards wrong could, however, come at a cost much greater than a decade of slow growth.
Alongside the Autumn Statement, the Office for Budget Responsibility released updated forecasts for growth and borrowing. Given recent events in the eurozone, along with high (although likely to ease) food and fuel prices, it was not a surprise that the figures for growth and borrowing had worsened since its March forecasts.
For 2012, the forecast for economic growth has fallen from 1.7 to 0.9% and public sector net borrowing is expected to be 8.4% of GDP. By 2015/16, the OBR expects the PSNB to have fallen to 2.9% of GDP, rather than the 1.5% it expected in March. What this means is that the coalition’s target for eliminating the structural deficit before the 2015 election will be missed.
Yet the coalition is, rightly, treating this as a short delay in reaching its targets. Easing fiscal plans would provide little or no benefit while risking higher interest rates and losing market credibility.
Osborne might talk a good game on deficit reduction but his willingness to follow through is less clear. The Autumn Statement placed too much emphasis on ‘eye-catching spending’, especially in infrastructure.
The chancellor needed to emphasise that for growth what really matters is not just temporary factors but the underlying potential of the economy. Weak growth makes it more important to ensure that decisions are based on clear cost-benefit grounds, not political whim.
Patrick Nolan is chief economist at Reform
