The next election’s fiscal mood music could be very different

Will Robert Chote’s OBR forecast away the £33bn hole in the public finances?

Share

Boom times are back!

Or so scream newspaper headlines as evidence mounts that the economy is picking up speed. Given the gloomy prognostications for growth just a few short months ago, the size of the apparent bounce is striking. What happens next is going to have big implications for politics and the public finances.

For almost three years, news about the state of the economy has been like listening to a particularly dreary dirge. Back at the emergency budget of June 2010, the chancellor set out unprecedented cuts that, it was thought, would fix the public finances over four years. By 2013, it was forecast, the economy would be growing at a good clip of 2.9 per cent.

But in its latest offering, back in March, the Government’s independent forecaster, the Office for Budget Responsibility (OBR), predicted growth of just 0.6 per cent for this year. That deterioration in the outlook, and the associated rethink about the damage wrought by the crash, had a huge impact on the watchdog’s assessment of the economy’s potential. And a smaller economy generates less tax revenue.

Since the OBR, led by Robert Chote, is also responsible for telling the chancellor whether his fiscal plans are sufficient to eliminate the budget deficit, those revisions had dire implications for the scale of cuts — or tax rises — the Chancellor needed to balance the books. That’s why George Osborne has pencilled in a further £33bn of cuts to public spending after 2015, some of which we heard about in the recent spending round.

Even by 2015, some government departments will be a quarter smaller than they were in 2010. So with health, schools, and pensioners all protected from further cuts, it’s hard to see how the extra savings can be made without decimating other public services and imposing some draconian working age welfare cuts.

But just as we were getting used to this gloomy timbre, somebody seems to have switch the record for a vigorous allegro vivace. There’s no denying that the economy is stirring from its two and a half year torpor. It grew by a respectable rate in the second quarter of the year, and subsequent data suggest that the third quarter could be impressive. Business activity jumped last month to suggest levels of expansion not seen since the 1990s. Retail sales growth is stronger than it has been for years. And, frighteningly, the government’s madcap housing policies seem to have succeeded in whipping up a fever in the housing market.

If the economic momentum builds into the autumn, all eyes will be on the OBR once again. Will they start tapping their feet to the up-beat tempo? Given recent data, it wouldn’t be surprising if growth this year ended up above 2 per cent. Quite apart from demonstrating just how much of a thankless task forecasting GDP growth is, that would be quite a turn around.

A bounce-back on that scale could send the OBR — and other forecasters — back to the drawing board. Among independent forecasters, views on the economy’s potential range widely. But if the bounce were to put the OBR in the camp of those who have until now been thought of as optimists, the impact on the public finances would be huge. As the chart above shows, based on a range of OBR projections, if you think the economy is currently running well below its potential, that implies the public finances will be in a healthy surplus by 2017 on current plans. Conversely, if you are even more pessimistic than the OBR’s March central assessment of a 2.7 per cent output gap, there will still be a deficit in four years’ time.

If estimates of the economy’s future potential were revised up by, say, two per cent, the £33bn hole in the government’s finances could all but disappear. It’s far too early to say whether such a large revision is likely. But as Jonathan Portes of the National Institute of Economic and Social Research has pointed out, looking at the early 1990s recession, it wouldn’t be the first time that respected commentators have ended up being way too pessimistic about the economy’s potential after a recession.

The political implications of this would be huge. The 2015 election would cease to be the shroud-waving spectacle it currently promises to be. Rather than competing to offer to least unpopular spending cuts and tax rises, politicians could get back to the much preferable task of arguing over how to spend the windfall or whether to give it back in tax cuts. Would a recovery prove that the Government was right all along with its policy of austerity?  Whether the economy would have taken off much sooner had the deficit cutting programme been postponed, avoiding huge economic damage, nobody knows.

Whether a sustainable bounce indicates that, backed by loose monetary policy, the economy was well capable of handling the cuts all along, nobody knows. Whatever the truth, for the Coalition a sustained economic turn-around would clearly be a powerful electoral asset.

So the prize is huge, but the big question is whether this nascent recovery is sustainable. Is this a brief respite before requiem resumes? Or the prelude to a triumphant crescendo? Sadly there are grounds for concern. A consumer-led recovery is all well and good, but with wage growth languishing well below inflation, shoppers are having to draw down their savings and put the bills on the credit card. Sound familiar?

The result is that the household savings levels have fallen back to where they were in the middle of the last decade. A consumer-led, debt-financed recovery doesn’t look much like the “march of the makers” that the Chancellor promised us.

The key to sustained growth is strengthening corporate investment. But that will only happen if companies think there are some customers out there, either here or abroad, to buy the resulting widgets. That in turn means that there will need to be a pick-up in wage growth to support the shoppers who are running out of economic puff, or a decent recovery in the eurozone to boost exports. Both look doubtful, even with the current ultra-loose monetary policy.

If there’s one thing we can take away from the bounce that nobody saw coming, it’s that nobody knows how the next movement goes. But either way, the next few months will have a profound impact on British politics.

Ian Mulheirn is outgoing director of the Social Market Foundation

React Now

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
iJobs Job Widget
iJobs General

IT Administrator - Graduate

£18000 Per Annum: Clearwater People Solutions Ltd: ***EXCELLENT OPPORTUNITY FO...

Project Officer (HMP Brixton Mentoring Project)

£24,000 per annum pro rata (21 hours per week): Belong: Work as part of a cutt...

Exam Invigilators needed

£45 - £50 per day: Randstad Education Chester: Randstad Education are currentl...

Looking for work in Secondary Schools?

£85 - £130 per day: Randstad Education Chester: Are you looking for work in Ed...

Day In a Page

Read Next
The colours of autumn leaves are among the many pleasures of the coming season  

In Sickness and in Health: As autumn arrives, more of us should wear high-vis clothes

Rebecca Armstrong
 

Daily catch-up: Scottish polls, canvass returns and arguments. And Top 10 Tweets

John Rentoul
Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

Exclusive extract from Janis Winehouse's poignant new memoir
Is this the role to win Cumberbatch an Oscar?

Is this the role to win Cumberbatch an Oscar?

The Imitation Game, film review
England and Roy Hodgson take a joint step towards redemption in Basel

England and Hodgson take a joint step towards redemption

Welbeck double puts England on the road to Euro 2016
Relatives fight over Vivian Maier’s rare photos

Relatives fight over Vivian Maier’s rare photos

Pictures removed from public view as courts decide ownership
‘Fashion has to be fun. It’s a big business, not a cure for cancer’

‘Fashion has to be fun. It’s a big business, not a cure for cancer’

Donatella Versace at New York Fashion Week