3rd December 2014
The Autumn Statement in the UK on 3rd December will be the Chancellor’s penultimate report on the economic and fiscal state of the country before the General Election in May 2015. It may not amount to more than political posturing and economic sophistry. While the former might be considered fair game given the proximity of the election, the latter carries no such excuse and will have enduring consequences for the country. Existing plans and targets for deficit and debt reduction are unattainable under current budget laws. To pretend otherwise is a deception.
Politically, the government will doubtless look to exploit opinion poll findings that give it a strong advantage over Labour with regard to trust in macroeconomic management. The government is expected, for example, to propose for the first time legislation to balance the budget by 2016-17, thereby appearing as the steady hand while simultaneously challenging opponents to oppose ‘fiscal responsibility’. At the same time, though, polls suggest the nation is tiring of austerity. To address this, the government is expected to propose tax reductions. We will be assured that steady economic growth and further reductions in public spending can go hand-in-hand.
The economics of the UK’s public finances, however, rest on more enduring and shaky ground. Even if the Office for Budget Responsibility still gives the Chancellor a pass on meeting his ‘fiscal mandate’, it is expected to confirm that public borrowing in 2014/15 will be around £15 billion higher than envisaged a year ago, and that the cumulative increase in public borrowing from 2014/15 until 2019/20 could be around £60-80 billion higher. The weakness of tax revenues is an important part of the reason reflecting continued stagnation in aggregate wages and salary formation, and the disproportionate growth in low wage, low skill jobs. This is a structural, and increasingly digital technology phenomenon, which will not diminish quickly without policy interventions, which are barely discussed.
In the meantime, the public deficit, debt and borrowing targets over the next five years, set out in the spring Budget, for example, are all likely to be revised higher. And the holy grail of a balanced budget and zero net borrowing will probably be pushed out again to the end of the decade. It can be assumed with some confidence that politicians will deny any possibility that the tax burden will have to rise in the next parliament, let alone what this might mean for the economy and the growth projections underlying the government’s fiscal arithmetic. In reality, that burden will have to rise.
The main economic reason is that the government can no longer rely on the fall in financial savings by UK households and companies to ‘finance’ the contraction in its deficit. Remember that the government’s deficit (net borrowing) and the financial surpluses (net lending) or deficits of households, companies and the rest of the world have to sum to zero. Since the difficult days of 2009-2011, the government’s deficit has indeed more than halved to about 5 percent of GDP, but this has happened only because the high net lending by households and companies has disappeared as of mid-2014. This is what has driven our economic recovery. The decline in the private sector’s surplus, however, has financed not only the fall in the government deficit but also a sharp rise in the rest of the world’s surplus, which is the counterpart of our external, or current account deficit. This is now an eye-popping 5 per cent of GDP.
As we look ahead, the private sector is no longer saving enough to finance the annual declines projected in the public sector deficit. The bloated external deficit might rise considerably further if the private sector’s balanced financial position shifts into deficit. This could lead easily to instability for the pound in the foreign exchange market, which might derail both fiscal and monetary policies. Politicians will have to sustain fiscal policy credibility because the political backdrop for the pound isn’t auspicious for stability either, with the possibility of weak coalition government, and continuing uncertainties about the UK’s relationship with the EU and England’s with Scotland.
The Autumn Statement will chart a steady-as-she-goes public deficit reduction course, but this option is rapidly becoming a mirage. Moreover, although the causes of an increasingly stubborn public deficit are not all well understood, the consequences of the policy status quo, let alone promises of tax cuts are. The public may not wear, and good economic sense will not justify, sole reliance on further significant cutbacks in public spending and services. The impetus behind the infrastructure debate is a case in point. Changes to tax laws and provisions are now needed as part of the strategy to keep deficit reduction on track, and to underpin market and political credibility.