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Q. So what was the verdict on the public finances?
A. Robert Chote and his team at the Office for Budget Responsibility (OBR) took a fresh look at the Government’s tax and spending plans and saw a large hole. Stripping out various one-off accounting changes, the OBR forecasts that the Treasury will now have to borrow about £100bn more over the next five years than it expected at the time of the March Budget. And this extra borrowing means the Government is no longer on course to hit the second part of George Osborne’s fiscal mandate, namely to have the national debt falling as a share of Gross Domestic Product in the year 2015-16. The OBR now expects the national debt to be rising in that year and not to decline until the following year. The OBR did rule that the Chancellor remained on course to hit the first part of his fiscal mandate, which is to eradicate the structural deficit (the part that does not disappear when growth returns) within five years’ time. However, he was only able to do so by pencilling in a further £4.9bn of austerity to take effect by 2017-18.
Q. Why have things got worse?
A. Because the UK’s growth outlook has deteriorated. In March, the OBR expected the UK economy to grow by 0.8 per cent over 2012. Now it expects a 0.1 per cent contraction. In March, the OBR expected 2 per cent growth in 2013. Now it sees an expansion of just 1.2 per cent. The outlook is bleak further forward too. Nine months ago the OBR thought the economy would grow by 3 per cent in 2015 and 2016. Now it thinks growth in those years will be just 2.3 per cent and 2.7 per cent respectively.
Q. Why is growth so weak?
A. The OBR blames export markets, mainly the continuing uncertainty across the channel. It said the eurozone debt crisis would “constrain UK growth for several years to come”. The forecaster also said that higher than expected inflation was responsible for the bleaker outlook. It also warned that higher prices would squeeze households’ spending power, hurting the all-important retail and services sector. The Labour Party says the Government’s cuts to infrastructure projects, such as school and road building, since June 2010 have contributed to the economy’s weakness by sucking demand and spending power out of the economy. The OBR does not buy agree. But the Chancellor apparently sees some merit in it because he has increased capital spending over the next two years by £5bn. The OBR says these measures will give only a “small boost” to growth.
Q. What does this all mean for us?
A. First it means more cuts. Welfare benefits will also be limited to a 1 per cent rise for the next three years, below the expected rate of inflation. The Chancellor did not outline where most of his cuts in future years will fall. But according to the Social Market Foundation think tank the Chancellor’s plans mean Government departments are now facing real terms budget cuts of 19 per cent between 2014 and 2018 (presuming the ring-fence around health, education and international development spending remains in place). Lower growth and more austerity mean more job losses, according to the OBR. The employment market has actually done better than the OBR expected in March. Nine months ago the watchdog expected the number of people in employment to flatline at 29.1 million this year. But, in fact, it has risen to 29.6 million, despite the shrinking economy. Yet the OBR does not expect this to last. It said yesterday that 1 million jobs would be cut from the public sector by 2018, up from the 730,000 expected in March.
Q. But should we believe what the OBR says?
A. As the final chart shows, the OBR has a pretty lamentable forecasting record. In June 2010 it said that growth in 2012 would be 2.8 per cent. Now it expects a contraction of 0.1 per cent. Almost every time the OBR has produced fresh forecasts of the economic outlook it has had to downgrade its previous, over-optimistic, view. Given this record, some are starting to question the organisation’s view. But the OBR’s forecasts cannot be ignored. A central part of its job is to estimate the size of the structural deficit. And the Chancellor has to commit to fill this gap in order to meet his fiscal mandate. But how big is this structural deficit? There is considerable disagreement among economists. And there is no way of knowing for sure. The OBR said yesterday that its model suggested that structural deficit was larger than it previously thought. But it chose to ignore its model and pick a lower number, thus sparing the Chancellor from the need to promise to inflict even more austerity on the rest of us.