The OBR forecasts trumpeted in the Budget are either implausible or undesirable. But they would allow the government to achieve its deficit reduction target
The Office for Budget Responsibility published its latest economic forecasts alongside the budget today. These forecasts show economic output - real GDP – increasing by 2.5 per cent in 2015. This is in no small part thanks to the collapse in the price of oil in the second half of last year. Together with a supermarket price war, this has caused inflation to fall to just 0.3 per cent in January. Wages are at last increasing faster than prices, allowing consumers to increase their spending, and this is what boosts growth in the OBR’s forecast.
Although this effect is likely to prove temporary, the OBR thinks growth in the UK will be sustained throughout the next five years. It forecasts average growth of 2.4 per cent over this period. However, this forecast is based on two implausible outcomes and one undesirable one.
Four types of spending combine to make up total demand in the economy: overseas spending on UK exports, investment spending by firms, consumer spending and government spending. The OBR’s forecasts are based on an implausible path for the first two and an undesirable one for the third.
The UK’s export share (exports divided by the UK’s export markets) has fallen by over 9 per cent over the last five years. The OBR thinks it will only fall by less than 3 per cent in the next five years. If this happened, it would represent a significant break in the recent trend, and allow exports to contribute more to growth. However, sterling is at a seven-year high against the euro, making it harder for UK-based firms to sell into the rest of Europe, which is still our main export market. And, although UK exports to some emerging economies have grown strongly, other countries are doing much better. The UK has a long-standing structural weakness when it comes to exports. The OBR’s forecast implies this can be overcome in the next five years, but it is hard to imagine why this should be the case.
The OBR also makes what looks to be a very optimistic forecast for investment spending. Investment spending as a share of GDP (in real terms) was 10.5 per cent in 2014 – up from 8.9 per cent in 2009; the OBR forecasts that it will increase to 12.5 per cent of GDP in 2019. This is equivalent to an average annual rate of increase of 6.0 per cent over the next five years, which substantially boosts real GDP growth over the period. If investment spending did reach this level, it would comfortably surpass the peak of the last 35 years, which was 11.2 per cent in 1998, though again it is not clear why this should happen.
Finally, the OBR forecasts that household debt will soar to a record 171 per cent of income by 2019, surpassing the 168 per cent peak in 2008. This is more plausible than its export and investment forecasts, though it would require a change in trend from the last few years, when the debt ratio has been moving slightly downward. But it is not a desirable outcome: that households could have more debt, relative to income, by the end of the decade than they had when the financial crisis hit.
The OBR makes these seemingly implausible and undesirable assumptions about exports, investment and consumer spending because this is the only way it can make its forecasts add up, given the path chosen by the government for its own spending – the fourth element of demand. Because the government plans to make substantial cuts to its spending over the next few years, other elements of demand have to grow strongly to compensate if the economy is to grow by almost 2.5 per cent a year. And the OBR has to forecast growth at this level, because if it is any weaker, a shortfall in revenues will make it impossible for the government to achieve its deficit target.
The OBR’s forecast, therefore, should be seen not as the most likely outcome for the economy, but rather as an outcome that would allow the government to achieve its deficit reduction target. To the extent that this requires the OBR to make optimistic assumptions about exports and investment, the risks to this forecast looks to be tilted to the downside.
Tony Dolphin is chief economist at the think tank IPPR
