The future of the economy is not yet outside our control

The Office for Budget Responsibility’s Fiscal Sustainability report, published this month, makes very depressing reading for anyone taking a longer look at the future of the public finances.  The Report, by the independent OBR (do we really believe that?) has forecast that public sector net borrowing would fall from 11.1% of GDP in 2009-10 to 1.5% in 2015-16 as government ‘fiscal consolidation’ (mainly cuts) is implemented, and that public sector net debt would peak at 70.9% of GDP in 2013-14 before falling back to 69.1% in 2015-16.

The new report looks to a much longer timescale, predicting greater pressures on the public finances in future decades.  Primarily as a result of an ageing population (the proportion of the population aged 65 and over is projected to rise from 17% in 2011 to 26% in 2061) and cost pressures on health and pensions, they say that unchanged policies would lead to debt continuously rising on an unsustainable upward path.  At the same
time, unchanged policies would lead to broadly stable revenues.

OBR say that additional fiscal tightening will therefore be necessary well beyond this Parliament.  On their central projections, government would need to implement permanent tax rises or spending cuts of 1.5% of GDP (£22Bn) from 2016-17.  They quote the same conclusion being made by the International Monetary Fund for western economies in their April Fiscal Monitor: “Although substantial fiscal consolidation remains in the pipeline, adjustment will need to be stepped up in most advanced economies, especially to offset the impact of age-related spending… From an even longer-term perspective, spending on pensions – and especially, health care – constitutes a
key challenge to fiscal sustainability.”

Tony Travers’ informative blog on the OBR report in Public Finance can be read here.

The crucial aspect of OBR’s analysis is the phrase ‘on unchanged policies’.  As David Blanchflower regularly and convincingly argues (for example here), if we want a better future we shouldn’t be starting here.  The ConDems austerity policies have led to a collapse in consumer confidence and rapid fiscal tightening has severely reduced the prospects for future economic growth, which would bring with it better revenues and reduced costs in unemployment.  He thinks double dip recession is still a possibility, depending largely on what happens in the USA.  Without Obama’s monetary and fiscal stimulus unemployment in the USA could already have been 25% rather than 10%, and similar, if smaller, impacts could be projected here.

The OBR report does not seem to assess the impact that fiscal tightening has on demand in the wider economy, appearing to believe public sector spending is only a cost burden, and that cuts in the public sector provide the room for increases in the private sector.  Blanchflower is particularly strong in showing that this is not the case.

It is interesting to note that in the OBR report the words housing and investment do not appear (at least not on my search).  Blanchflower has particular concerns about the potential increase in negative equity amongst homeowners if interest rates rise, but it seems a weakness that OBR never distinguish between different types of spending, and especially between capital and revenue.  To OBR, borrowing is borrowing and no
distinctions are made.  Gordon Brown’s first fiscal rule, that borrowing over the cycle should equal investment, with government income covering government revenue spending, aways seemed like a correct approach, and is a good place to get back to.  But it doesn’t tell you exactly how much investment there should be.  Construction has always been a sound purpose for public borrowing and the benefits have been described many times: reducing pressure on government revenue deficits, strong social outcomes and better underpinning of other public objectives (especially in health), and, crucially, a high multiplier in the private sector as the initial investment leads to increased spending in the wider economy.

We know it will take a generation of increased housebuilding to bring housing demand and supply closer to equilibrium.  There is no prospect of that whatsoever under current policies.  But it would be interesting to see what impact a major housing investment and construction-led economic stimulus, lasting for 20 years, would have on OBR’s dire long term projections for the 2020s and 2030s and beyond.  The economic future is not yet outside our control.

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