George Osborne is clear how he wants us to regard the Budget he delivered on Wednesday. It’s to be thought of as a budget for growth. The story he wants history to tell about the economic policy of this government is one of rescue followed by reform and culminating in recovery. But will his policies produce the recovery and growth he hopes for, or are we heading for stagnation and the economic doldrums?
Like all chancellors, Mr Osborne included in his budget lots of measures intended to make the economy more productive. He cut corporation tax, announced twenty one new enterprise zones, took action to boost apprenticeships, opened the way for an easing of planning regulations and so on. His aim is to rebalance the economy away from dependence on financial services and domestic consumption and towards more investment and exports.
But beyond such so-called ‘supply side’ measures, the biggest determinant of how much an economy will grow by is how much spending a government allows to take place: in economic jargon, how much ‘demand’ it allows. It’s here that his policy is most controversial.
From the moment the Coalition came into office last May it said that its overriding priority was to reduce the size of the annual government deficit (running at about 11% of annual national income) and so also reduce the total volume of government debt. The deficit had ballooned as a consequence of the recession that followed the world financial crisis that began in 2007. The Government’s case was that the scale of the deficit problem had been made worse by the levels of borrowing the last Labour government had allowed to develop even in the boom years before the financial crisis.
The Government’s plan was to eliminate what’s known as the structural deficit – the amount of borrowing that would not naturally disappear as a result of a return to normal levels of economic growth – by 2015, the date by which the next election will have had to be called. In fact the Government hopes to achieve this goal a year earlier.
To do this the Chancellor announced in his first Budget last summer huge cuts in public spending and tax rises over the course of the parliament, beyond those already decided upon by the outgoing Labour government. Such tax rises and public spending cuts inevitably reduce the level of demand in the economy.
Mr Osborne argued that this was not just a necessary ‘rescue’ package to deal with an unsustainable deficit but also a strategy for growth. His case was that if he had let projected government borrowing levels stay higher then the financial markets (which provide the loans) would have demanded much higher rates of interest in order to be prepared to do so. We would have risked becoming like Greece, Ireland or Portugal, which have to pay interest rates of 7% or 8%, whereas, by tackling the deficit, the British government has to pay only about half that. These lower interest rates are good for growth and by taking Britain out of the ‘financial danger zone’, the government claims it has created stability that is also good for growth. The Chancellor cites the IMF, the European Commission and the OECD as supporters of this approach.
The trouble, though, is that far from growing faster, the economy is showing every sign of slowing down. Last year, the economy was growing at 1.1% pa in the second quarter, 0.7% in the third and actually shrank by 0.6% in the final quarter. The independent Office for Budget Responsibility yesterday reduced its estimate of growth in 2010 from 1.8% to 1.3%. It also reduced its growth forecast for this year from 2.1% to 1.7% and reined in its forecasts for the next two years. One effect of these reduced growth forecasts is that government borrowing is set to be £45bn more between now and 2015 than Mr Osborne expected it to be.
It’s not hard to see why the OBR should be predicting slower growth. Partly as a result of higher oil prices (itself in part a reaction to the turmoil in the Middle East), inflation is turning out to be higher than expected. This is eating into the value of people’s incomes at a time when wage rises are constrained by the shadow of unemployment. As a result, consumer confidence is very low.
The Chancellor acted to cut fuel duty to ease things a bit but the prospects for consumers are not good. Unemployment is rising, taxes and national insurance are going up next month and public spending cuts will start to bite pretty soon. The TUC is organising a big demonstration against them this Saturday.
Labour’s case is that the Government is trying to cut the deficit too quickly. It should be doing what the Obama administration is doing in the United States: allowing government borrowing to go on taking the strain in order to keep up levels of demand and so boost growth. It is working there, they say, and could do so here.
The argument is that though it certainly is the case that the economy needs rebalancing towards investment and exports – and both manufacturing and exports sales are doing very well at the moment – domestic consumption remains far and away the biggest contributor to demand. Consumer confidence is dire and the Government’s policies are going to make it even worse, say the government’s critics.
The OBR has not boosted its forecasts for growth in the short term as a result of the specific measures the Chancellor took in his Budget to stimulate growth but it is forecasting that the economy will return to a healthy growth rate of 2.9% by 2014. The trouble is, though, that economic forecasts do not have a very record of turning out to be correct. In particular, growth forecasts tend to be over-optimistic and inflation forecasts to undershoot what turns out to be the case. If the same happens now, Mr Osborne could find himself in a very difficult position.
The truth is that no one really knows how it is going to turn out and in that sense it is all a gamble. If the Chancellor’s punt turns out to be right, he will have significantly cut the deficit by 2014 and, on the back of a booming economy, be able to deliver a give-away budget in time for the next election. But if it turns out to be wrong, the economy could stay stuck at very low levels of economic growth or none at all. Then the clamour for a Plan B will become deafening and Labour will claim to be vindicated in its opposition to Mr Osborne’s strategy.
What’s your view?
- Do you think the Chancellor was right or not to stick with his ‘Plan A’, of making deficit-reduction his main priority?
- What do you think of his specific measures to boost growth, such as the cut in corporation tax and the setting up of more enterprise zones?
- Consumer confidence figures are very bad: how much do you yourself feel the need to pull in your horns?
- What are the factors that affect how much you think you will want to spend over the next year or so?
- Do you think you will be directly affected by the coming cuts in government spending?
- To what extent do the measures which the Chancellor took to help consumers (such as cutting fuel duty and raising the income tax threshold) make you feel more willing to spend?
- Do you think Labour’s case for a more gradual reduction of the deficit is right or not?
- And do you think we shall move from rescue to recovery, as Mr Osborne calls it, or that we’ll stay stuck in the doldrums?
Let us know your views.