Osborne's Impossible Fiscal Plans Do Little To Tackle The Real Problems of the British Economy
Chancellor George Osborne has announced a more ambitious set of targets for fiscal policy than those he set out while in coalition with the Liberal Democrats. Rather than seek to balance the current budget he will aim to run an overall surplus in ‘normal times’. ‘Normal times’ are yet to be defined.
While the need for a degree of austerity to rein in one of the largest structural deficits across the OECD is clear, the Chancellor’s argument that high government debt contributed to the crisis, or that reducing it will by itself deliver sustainable growth is far less convincing. The excessive level of public debt at the time the crisis began made it worse than it might have been, but the real source of the UK’s crisis was excessive bank lending to households, leveraged against a grotesquely over-valued housing market. Moreover, the only known means to sustainable growth and rising living standards is productivity growth. And while the Chancellor is rightly frustrated at still presiding over one of the largest structural deficits in the OECD, it is the UK’s woeful productivity performance that deserves his attention above all else.
The roots of this dire performance lie firmly in the failure of policymakers, which includes the Bank of England, to grapple with the underlying causes of the UK’s real debt problem - namely household sector debt, and the banks that supplied it. Unless and until the housing market is allowed to clear, and debt is brought back down to Earth, there is little hope for a sustainable recovery in the UK. But instead the Chancellor has chosen to tinker with, and artificially boost housing demand, stopping the nascent deleveraging process in its tracks in 2013. Even George Orwell would not be able to fathom the logic of public debt bad; private debt good. Debt is debt, and the UK has far too much of it, most of it in private hands.
The real source of the UK’s crisis was excessive bank lending to households, leveraged against a grotesquely over-valued housing marketThat brings us on to the question of whether a government budget surplus is always necessary. Across the developed world, budget surpluses are rare as hen’s teeth. Indeed, the OECD as a whole has not run a budget surplus in any single year since at least 1960. The UK has fared a little better. Since 1900, it has run a budget surplus, on average, once every four to five years. But most of those were in the immediate post-War period, and even those were vanishingly small.
Of course, the fact that achieving a budget surplus has proved challenging in the past does not mean that one should give up trying. Indeed, the crux of Chancellor Osborne’s argument is that the only way to deal with the risks to fiscal sustainability posed by excessive debt levels is to run a series of budget surpluses. But is he right?
At the end of financial year 2014/15, public sector net debt stood at around 100% of GDP. Some, like Paul Krugman, would argue that is a trifle, compared to the 260% of GDP it reached in 1946. But, the household sector debt burden is far larger now than it was in the aftermath of the Second World War. Taken together, gross household and public sector debt now amount to some 200% of GDP, which is not too far off its all time peak. However, between 1946 and 1956 public sector net debt halved in just ten years, falling to 130% of GDP by 1956. And yet, during that period, the level of debt changed very little and the UK ran a budget surplus in just five years. It ran a deficit in the other five. What did most of the work was economic growth. Real GDP growth averaged 2.5% during that ten-year period, while inflation averaged 5.3%. Cheap financing helped too, with the effective rate of interest on government debt significantly below the rate of inflation.
fix the productivity crisis, and the public finances will take care of themselvesFinally, there is the small matter of whether the Chancellor’s implied cuts are achievable. The ambitious spending cuts set out by the Coalition back in March 2015 looked improbable.
Public sector net borrowing excluding the cost of the financial bailout fell by £66 billion during the five- year term of the Coalition government. Under the Coalition’s plans, borrowing was expected to fall even further, and by £95 billion, by the end of the present five-year parliament. With tax receipts forecast to stay relatively stable almost the entire reduction was expected to come from spending cuts, when, presumably, the low-hanging fruit has already been gathered.
In order to meet the Coalition’s fiscal mandate, the spending cuts set out in March 2015 were already front-loaded. Departmental spending was set to fall by some £30 billion during the first three financial years of the present parliament. But with schooling and health both ring-fenced, unprotected departments were likely to face cuts of almost 20% in real terms. If carried out, department budgets will have been cut by a third since 2010.
Osborne’s new plans are even more severe, turning the improbable into the impossible.
What might the new framework imply for spending? Let’s be generous. Let’s assume that the UK economy has not yet returned to normal, and that the requirement to run an overall budget surplus does not bite until 2017. Moreover, let us assume that the Chancellor aims for a surplus of just one penny. The fact that capital expenditure is no longer exempt from the fiscal mandate would by itself require an additional £17 billion of cuts.
There undoubtedly comes a point where a country’s debt burden can threaten its financial stability. But the Chancellor’s focus and hence his prescription completely, perhaps deliberately, misses the point. The danger to the UK comes from excessive private sector debt and a broken banking system which together are holding back its productivity. So, my advice to Chancellor Osborne is simple: fix the productivity crisis, and the public finances will take care of themselves.
Danny Gabay is Co-Director of Fathom Consulting in London.
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