False economies and economic falsehoods

25 Nov 15

It can be instructive to look at the logic of Osborne’s latest Spending Review from the other end of the telescope

“Nothing is possible without the foundations of a strong economy.” So said the chancellor in his Autumn Statement today, in a reworking of one of the government’s favourite (and effective) retorts to criticisms of its obsession with fiscal discipline: that “you can’t have [insert desirable outcome] without a strong economy”.

But what if that statement were turned on its head (and the bad grammar indulged): what can’t you have a strong economy without?

Investment in skills and innovation would have to come near the top of the list, and the chancellor’s announcements today to protect spending on adult skills, 16-19 education and science are therefore welcome. Also welcome is the commitment to boost spending on transport infrastructure, although the UK has some catching up to do after investment stalled post-2010.

Another pre-requisite for economic strength would have to be a balance between consumption spending and investment as contributors to growth. In this regard the Office for Budget Responsibility’s latest forecast neatly encapsulates how little the fundamentals have changed since the UK was plunged into recession in 2008. It shows that growth over the next five years will be underpinned by household consumption which will, in turn, be underpinned by debt: the household debt-to-income ratio is expected to reach 163% by 2021 – a slight downward revision from the forecast the OBR published alongside the summer budget, but still ominously close to the pre-crisis high.

The ratio of household net worth to income is expected to remain stable, but that is predicated on relatively strong and stable house price inflation over the forecast period: the ratio would worsen considerably if house prices were to fall. And strong house price inflation is itself a problem, not least because it means the various interventions announced today to bolster home ownership will be chasing a moving target. 

Although business investment is forecast to rise, the projections look, to put it mildly, optimistic. By 2020, investment is predicted to account for 12% of GDP – even though it hasn’t broken the 11% level in real terms in more than 35 years. In the OBR’s own words: “our forecast [for investment] is subject to considerable uncertainty”.

Can you have a strong economy without a healthy export sector? The OBR is also predicting a disappointing trade performance over the next five years, with trade making either a zero or slightly negative contribution to growth from next year. This is partly as a result of a weakening global outlook, but as we have argued, the UK’s export sector has lost ground against its competitors in recent years, both in terms of the variety and the complexity of the products it can offer to consumers abroad. George Osborne has gone very quiet on his target to double exports by 2020, in all likelihood because there is virtually no chance of getting close to meeting it.

If asked, Osborne would undoubtedly list fiscal discipline as his first pre-condition for a strong economy, and the chancellor is making both local and national government work extremely hard to deliver a budget surplus by the end of the parliament. But without a plan to address the UK’s fundamental economic imbalances, the next shock to hit the UK economy – or even just a revision to the mysterious “unpublished data” used by the OBR in its forecasts – will send the public finances straight back into the red.

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