Are the books really in as bad a mess as the coalition says?

The new fiscal watchdog is not reading from the same script as the Government that created it, says Sean O'Grady
Click to follow
Indy Politics

The new independent Office for Budget Responsibility (OBR) has slashed the forecasts for growth in the British economy – and warned that the "structural" budget deficit – that part which will not disappear as the economy improves – is worse than Labour stated.

However, the modest scale of the revisions to Alistair Darling's forecasts in his March Budget appeared to run contrary to some of the dramatic rhetoric recently deployed by David Cameron, George Osborne and, in a speech yesterday, the Deputy Prime Minister Nick Clegg.

In cash terms, borrowing over the next few years will be lower than the Labour government said, as tax revenues have held up better. Borrowing this year will be £8bn less, and £23bn less over the next five years. But the sluggish growth forecasts mean that the structural deficit will be larger in relation to the size of the economy. The cost of servicing a national debt of around £1.4trn is set to peak at £67bn, a little short of Mr Cameron's estimate last week of £70bn a year.

The OBR's downgrades come as one of the world's leading economists, Joseph Stiglitz, warns in The Independent that the case for more cuts is "weak", and that the UK and the rest of Europe risks a "disastrous" slide into a double-dip recession.

The Chancellor, George Osborne, accused Labour of "fiddling the figures" and said the economic situation was "worse than we thought". The former chancellor, Alistair Darling, replied that "I do not believe we should take risks with our economy while our growth is underway. It is so fragile and it would be playing with thousands of people's jobs." He has accused Mr Osborne of "exaggerating the scale of the difficulties we face in order to justify the things he has wanted to do anyway".

The Deputy Prime Minister, Nick Clegg, said that public sector pensions were "unfair and unaffordable", adding, "Our problems are more serious than we realised."

The Government is thought to be looking for new spending cuts of £60bn a year by 2015. Jonathan Loynes, chief european economist at Capital Economics, commented: "The OBR has taken a surprisingly optimistic view of the outlook for the UK public finances. The key question now is what the forecasts imply for next week's emergency Budget. On the face of it, they might seem to relieve the pressure for an additional fiscal tightening, or even make room for tax cuts. But we suspect that the Government will still wants to err on the side of caution, if only for political reasons. We still expect a pretty tough Budget next week."

The National Institute of Economic and Social Research added that ministers will have to be prepared to increase taxes.

The British economy will grow by 2.6 per cent next year, said the OBR, a lower forecast than Mr Darling's previous estimate of 3.25 per cent. The OBR says that the economy will recover to see growth of 2.8 per cent in 2012 and 2013, before slipping back to 2.6 per cent in 2014. By contrast, Mr Darling foresaw the economy returning to a robust expansion of 3.5 per cent a year from 2012.

If the OBR's projections prove correct, then the UK economy will struggle to better its 2008 peak levels of output by the end of this parliament. In cash terms, the UK economy will be some 3.75 per cent smaller by 2015 than the Labour government had assumed – a reduction in output of around £50bn.

More worrying is the OBR's assumptions about longer-term growth. The OBR says that "trend growth" in the British economy will be 2.25 per cent over the next three years, dropping to just over 2 per cent after 2014, "as demographic changes reduce the growth of the potential labour supply". An ageing population and lower immigration will see the UK's long-term growth rates return to levels much lower than the 2.75 per cent a year seen for much of the past decade, and lower than the growth seen in the 1950s and 1960s. Even so, the OBR estimates that net migration will amount to 140,000 a year – some 40,000 higher than Mr Cameron's election pledge.

The structural budget deficit is estimated to be 2.8 per cent of GDP, or £50.5bn by the end of the five-year projected life of the coalition – 0.3 per cent higher than in the last Budget, or £5.5bn higher in money terms. The Budget, next Tuesday, will put more detail on plans for the public finances. It is likely to be the harshest Budget since 1981. Though little debated in the election campaign, an increase in VAT to 20 per cent from next year is widely tipped by City economists.