This is no time for a pre-election spending spree

By Diane Coyle
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The Independent Online

Gordon Brown faces a great temptation. It is not one he will yield to this week, in this year's draft Budget, but it will dangle in front of him again in March, in the run-up to a likely May election. It's this: the possibility of making perhaps an extra £15bn available for public spending without any increase in taxation.

Gordon Brown faces a great temptation. It is not one he will yield to this week, in this year's draft Budget, but it will dangle in front of him again in March, in the run-up to a likely May election. It's this: the possibility of making perhaps an extra £15bn available for public spending without any increase in taxation.

Indeed, the tax burden could be shown to be falling. It would, however, be exactly the wrong time to fall for the temptation. A truly prudent Chancellor would have to resist for another two or three years.

This is the alluring possibility. The Government's tax and spending plans are based on the most cautious of assumptions. Mr Brown has rightly ruled out unsustainable expenditure, and his stewardship of the economy would deserve praise for this if nothing else, so difficult have past chancellors found it to deliver sound finances. So the public finances must satisfy two rules. The "golden rule" says the government borrows only to finance investment, and current spending has to be in surplus. The sustainable debt rule caps the amount of borrowing even to invest. Together, these guarantee that interest rates can stay relatively low.

On top of the fiscal rules, the plans have been set up to deliver nice, but never nasty, surprises. The surplus has always turned out bigger than expected, not smaller. This can be achieved by playing it safe on the assumptions used by the Treasury to forecast tax revenues and expenditure on items like unemployment benefit.

One of the key assumptions concerns the economic cycle. The rules apply to the "cyclically adjusted" budget balance, since if there were a recession, any sensible chancellor would want the leeway to spend more as tax receipts fell. The converse is that there has to be a surplus when times are good, as they are now. But how can we tell where the economy is in the business cycle?

The answer is that it depends on what you think the long-run trend is. And it is in this assumption about long-run growth that temptation lies. The current spending plans make the ultra-cautious assumption that the UK economy can grow by 2.25 per cent a year over the long term. Forecasts for future revenues are derived from that figure. If trend growth is actually more than 2.25 per cent, then government revenues will grow faster than expected, too, making additional spending affordable and prudent.

This thought has clearly crossed Mr Brown's mind. In a speech he made in Prague in September, he indicated that trend growth was probably a little higher than forecast, although he insisted then he was sticking with the lower number for the purposes of planning expenditure. But think of the allure of an extra 0.25 per cent a year of GDP in perpetuity. Thanks to the beauty of compounding, that quickly clocks up many extra tens of billions of pounds to spend on hospitals, schools and railways that work.

Unfortunately, this would be exactly the wrong stage of the economic cycle at which to declare an improvement in trend growth, as any policymaker who lived through the disastrous late-Eighties decision to declare an economic miracle can testify. That was a mistake, and the consequence was record public-sector net borrowing. A long and vigorous economic expansion inevitably raises the average growth rate, and the UK has enjoyed just such an expansion in recent years. There are other encouraging signs too, especially in the jobs market. The benign combination of falling unemployment and pretty stable pay growth indicates that the economy has changed for the better at a deep, structural level.

Then there is the hope of a New Economy boost like that enjoyed by the US. As Charles Bean, the Bank of England's new chief economist, pointed out in his interview with the Independent last week, the US productivity miracle arrived from nowhere about five years ago, so given the usual delays in any trend crossing the Atlantic, this is about the time we might hope to see something similar emerging here.

There is absolutely no sign yet, though, of an emerging productivity boom. On the contrary, the UK's productivity performance has been miserable for almost a decade, much weaker than in previous economic upturns. Until there is some solid evidence of improved productivity performance, it would be premature for the Chancellor to spend the fruits of an economic miracle.

Indeed, the time to declare a miracle is not at the peak of the boom but rather at the trough of a downturn. If GDP growth and productivity growth can stay higher on average over the course of a whole business cycle, then we could be fairly confident about an improvement in the trend.

The improvement spied by Mr Brown is probably real. There are good reasons to believe the supply-side of the economy has continued to become more flexible and dynamic. But he should resist increasing public spending on those grounds until well after the next general election.

* d.coyle@independent.co.uk

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