Over 24 hours and counting, and the Autumn Budget still hasn’t unravelled. These days that probably counts as a win. The newspaper coverage has predictably split along party lines, but the consensus seems to be that Philip Hammond played a bad hand reasonably well. The Chancellor avoided some obvious pitfalls – such as lowering the VAT thresholds for small businesses – while spending smallish sums of money in enough areas to keep the kiddies happy at Christmas.
Nonetheless, any cheer has been overshadowed by two pieces of bad news. The first is the much gloomier assumptions about productivity, an unwelcome gift from the elves at the independent Office for Budget Responsibility (OBR). The OBR, like most forecasters, has consistently been too optimistic about productivity since the financial crisis. It has now chucked in the towel and assumed that output per hour worked will remain significantly below its pre-crisis trend. This in turn implies a lower profile for economic growth and a worse outlook for the public finances.
But on top of this, the Chancellor has added to the budget deficit further with a package of tax cuts and increases in public spending. Indeed, he appears to have redefined the concept of a ‘balanced budget’. It is no longer about eliminating the deficit. It now seems to mean responding to as many competing political pressures as possible. As a result, the deficit, initially supposed to have gone by 2015, is still expected to be £25bn in 2023.
That may not be a big number in itself. But since 2000, when the government last balanced its books, public sector debt has climbed from 28% of national income to more than 86%. Even at current low interest rates, that is a huge burden to hand to younger generations. The Budget sweetener of a few more years of cheap rail travel is not much consolation.
As it happens, I think that the OBR’s assumptions about productivity are now too pessimistic. This might yet rescue the fiscal numbers too. The OBR’s forecasts are taken too seriously. In this Budget, for example, a lot was made of the fact that economic growth is forecast to slow from 1.5% in 2017 to 1.4% in 2018 and 1.3% in 2019, before picking up again. As if anyone can forecast GDP to the nearest decimal place!
To be fair, the OBR acknowledged that ‘huge uncertainty remains around the diagnosis for recent weakness and the prognosis for the future’. But it is therefore all the more important to question these forecasts, and the assumption that the UK’s relatively poor performance on real wages and on productivity is due to a low level of investment. Too often this seems to lead to the conclusion that the only way to boost living standards is to increase investment by, or directed by, the state.
For a start, the weakness of real wages can also be explained by a series of exceptional factors since 2010, including two hikes in VAT, shifts in the composition of the labour market, the public-sector wage freeze, large scale migration from the EU and, most recently, the fall in the pound. Crucially, all these pressures have now ended, or will do so soon, while the labour market has continued to tighten. As a result, real wages should recover of their own accord.
In the meantime, UK’s productivity performance has not been as bad as the headlines suggest. In part it is simply the flipside of rapid growth in employment – a good thing – due to the UK’s relatively flexible labour market. As the economy runs short of new workers, companies will have every incentive to prioritise gains in productivity once more.
Two other developments should also help to raise productivity with no further action from the Chancellor. One is the return of interest rates towards more normal levels, increasing the incentive for banks to lend and encouraging the reallocation of resources to more productive uses. The other is an easing of uncertainty about the impact of Brexit, which should encourage companies to look again at new investment projects.