The Chancellor is still gambling on strong medium-term growth

At the time of the last Autumn statement, the Office for Budget Responsibility (OBR) was predicting growth of 0.7 per cent in 2012, followed by 2.1 per cent in 2013, 2.7 per cent in 2014 and a robust 3.0 per cent in 2015. Yet again, these forecasts have been downgraded, to -0.1 in 2012, 1.2 per cent in 2013, 2.0 per cent in 2014 and 2.3 per cent in 2015. Forecasts of strong growth of almost 3 per cent have now been put back to 2016 and 2017.

Despite the unreliable nature of such forecasts, the Chancellor is still gambling that strong medium-term growth and the consequent increases in tax revenues will allow him to meet borrowing targets without making radical spending cuts. So far this strategy has not been successful. As a result of lower-than-expected growth over the last two years, government borrowing in 2012/13 on a like-for-like basis will be around 50 per cent higher than projected in the original deficit reduction plan. Borrowing in 2013/14 is now forecast to be almost double the figure expected back in 2010. At around 7 per cent of GDP, it will remain at a similar or higher level than in several countries currently experiencing debt crises, such as Italy, Spain and Portugal.

In addition, there are good reasons to believe that the long-term ‘trend’ rate of growth in the UK has declined over the last decade or so. This reflects a large rise in public spending – to a peak of 50 per cent of GDP – as well as an expanded regulatory burden on businesses. Moreover, various government stimulus policies since 2008 have hindered recovery by preventing necessary adjustments, such as the liquidation of boom-time malinvestments and the reallocation of resources to more productive activities. Going forward, significant increases in energy and transport costs, resulting from the government’s environmental policies, are likely to have a negative effect on economic output. And, as the Chancellor mentioned in his statement, the ongoing euro zone crisis adds further uncertainty to the medium-term growth outlook.

In this context, the Treasury is taking a major risk in basing its deficit reduction plans on growth forecasts that are likely to be inaccurate. Given that government borrowing remains at dangerously high levels, and that the confidence of the bond markets could quickly be eroded if outcomes disappoint, there is a strong case for taking much more radical action to reduce public spending. The real terms reductions in working-age benefits are a good start, but the Chancellor could also have acted to cut age-related benefits, as well as abandoning the coalition’s deeply unpopular plan to increase foreign aid. Significant medium-term savings could be achieved by cancelling major projects such as Trident and High Speed 2. The IEA’s recent publication, Sharper Axes, Lower Taxes, provides a long list of potential savings.

5 December 2012, IEA Blog


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