George Osborne will have to include something in his March 21 Budget to boost the economy. His options are limited but there is one radical step he could take
The chancellor approaches his Budget on March 21 with all the important economic indicators looking pretty gloomy. Last November, the Office for Budget Responsibility delivered a game-changing downgrade of its outlook for the UK economy. The result is that a further £15bn of annual cuts will be needed by 2016/17 to keep the deficit reduction on track.
Such a rapid deterioration in the outlook for the public finances is alarming. It certainly brings home the urgency of kick-starting economic growth. Without it we’ll be looking at yet another extension of the already record period of spending cuts.
The Budget is George Osborne’s first opportunity since the OBR reassessment to offer a policy response. There’s likely to be a bit of tinkering, and perhaps a little progress towards the Liberal Democrat goal of a higher tax allowance. But what are his big-picture options to change the growth outlook? There are four.
The default option of no policy change is the obvious starting point. Concerned about the reaction of the bond vigilantes to any wavering on the tough spending plans, the Treasury could read the OBR’s assessment as requiring redoubled commitment to the existing strategy. The chancellor might even go further and indicate where he intends to get the other £15bn from. Is it really credible to leave that decision to 2014, just before an election?
The problem with this approach is two-fold. First, it might start to do more harm than good to investors’ confidence that the UK can handle its debts. Spending-cutting credibility is one half of deficit-cutting: you also need growth.
Second, doubling down on austerity can work only if it retains public support. Any further downgrades of the growth outlook could undermine political support for the strategy. A more pragmatic approach is advisable, and there is some scope for that within the chancellor’s fiscal rules.
So what about some kind of ‘Plan B’? There is scope for short-term stimulus measures within the fiscal rules. But a temporary tax cut is unlikely to have a big impact on output and could frighten the bond markets. Much-needed capital investment in the UK’s creaking energy and transport infrastructure, on the other hand, would be a valuable use of the money – and wouldn’t raise the current spending deficit. But even here the Treasury remains cautious.
So option three, which featured large last November, is to outsource Plan B: get pension funds to invest in infrastructure, and boost business investment by guaranteeing loans to small and medium-sized businesses. If this sounds a bit like having your spending cake and eating it, that’s because it is. Whether the Treasury underwrites the risks of others’ investments or makes those investments directly makes little difference to the UK’s creditworthiness. It just looks better on paper. Perhaps the government hopes that the bond market won’t notice the liabilities piling up at the Treasury. Either way, unblocking the necessary private investment is likely to take a long time. A more immediate solution is needed.
The remaining option has been absent from the debate until now. The government could stick to its spending plans but do something radical with what it spends the money on. The best way to keep the bond vigilantes at bay is to find a more growth-friendly configuration of the UK’s £700bn of public spending. Things like savings tax breaks for high earners actively suck money out of the economy, while giveaways to rich pensioners are liable to be saved. Directly channelling this money into infrastructure investment would have a substantial impact on growth.
The risks to investor confidence of greater spending or persistently low growth are finely balanced, and the UK’s path between them is becoming narrower and more precarious. A radical re-engineering of spending would boost growth and strengthen the credibility of the chancellor’s deficit reduction plan.
The Social Market Foundation's report, Osborne’s choice, was launched on February 20
