Autumn Statement: Borrowing better than expected but the squeeze goes on

Wages in cash terms have been rising only very slowly in recent years

What is the big economic picture from the Autumn Statement?

First the good news: the Office for Budget Responsibility (OBR), the Government’s official forecaster, has revised its near-term growth forecasts upwards since its last report in March. The OBR thinks growth this year will be 3 per cent – up from its previous 2.7 per cent prediction. It also sees growth next year coming in at 2.4 per cent, slightly higher than its former estimate. However, the forecaster now thinks growth in the subsequent three years of its forecast period will be weaker, something it attributes to the stuttering of the global economy. In particular the eurozone economy, which sucks in half of Britain’s exports, is doing worse than the OBR expected earlier in the year.

What does that mean for living standards?

On wages the message is mixed: the OBR has had to downgrade its forecast for average earnings growth in 2014 to just 1.8 per cent. That’s down from the 2.5 per cent growth it estimated in March. It also sees growth of just 2 per cent in average earnings in 2015, down from a 3.2 per cent estimate earlier in the year. There is a further downgrade for 2016 earnings growth. This reflects the fact that wages in cash terms have been rising only very slowly in recent years.

So people will be worse off?

The squeeze on living standards implied by weaker wages growth is moderated by the fact that forecasts of higher consumer price inflation have also been revised down by the OBR. Inflation for 2014 is now seen coming in at 1.5 per cent, rather than 1.8 per cent. In 2015 it is forecast to be just 1.2 per cent, rather than 2 per cent. That means that, if the OBR is correct, wages will still rise by more than the rate of inflation.

The forecaster also thinks that the unemployment rate will drop more rapidly than it did in March, declining to just 5.2 per cent in 2016.

Is the economy finally rebalancing, then?

Certainly not under the OBR’s forecasts. Hopes that exports would drive the recovery have been pretty much discarded. Over the next five years, trade makes no net contribution to the UK’s economic growth, according to the OBR. And household consumption is also seen as making a greater contribution each year than business investment.

The OBR sees the household savings rate falling further to support growth, and household debt rising steadily over the period, returning to pre-crisis levels. Although house prices seem to be growing less rapidly than in March, much of the rise in aggregate household debt is attributed to the public buying more expensive houses over the next five years.

The OBR is also more pessimistic in its latest report about the productive capacity of the economy. It sees this year’s unexpected growth spurt as a cyclical bounce-back, rather than something that suggests stronger underlying growth. As a result, the OBR has halved its estimate of the amount of slack in the economy since March to just 0.6 per cent of GDP. This means the OBR thinks there is no scope for the economy to grow at faster than normal rates without running the risk of triggering inflation.

What does all this mean for the public finances and state spending?

The OBR was forced to recognise today that, despite stronger than expected growth this year, the fiscal deficit (the amount the Government borrows each year) is not dropping as fast as it expected in March. This is mainly due to income tax receipts falling short. A great many of the new jobs that have been created over the past two years are relatively low paying, which means they pay less tax.

The Government’s successive increases in the tax-free personal allowance to £10,000 have also removed many people from income-tax liability. As a result the forecaster now says total state borrowing will be £91.3 in 2014-15, £5bn higher than it expected in March. It will also be £75.9bn in 2015-16, £7.7bn more than the last estimate. However this means that the deficit will still continue to fall in cash terms each year. And the OBR also surprised analysts by saying public borrowing between 2016-17 and 2018-19 will actually be lower than it expected in March.

How on earth does that work?

It’s complicated. This downward revision in later years seems to be due to a combination of lower welfare outlays and lower government interest payments on the national debt. In a nutshell, weaker than expected inflation and the likelihood that the Bank of England will keep monetary stimulus in place for longer turns out to have a positive impact on the public borrowing forecasts.

Will the Government hit its fiscal targets?

The fiscal mandate compels the Government to be on course to run a surplus on its day-to-day spending, adjusted for the economic cycle, within the next five years. The OBR says that, despite the near-term slippage in borrowing, this particular target will still be struck in 2017-18, two years earlier than necessary. Furthermore, there is now projected to be a 2.3 per cent of GDP surplus in 2019-20 on this measure of borrowing. The other part of Mr Osborne’s fiscal mandate was to have the national debt falling as a share of GDP by 2015-16, but this was ditched several years ago when the economy stagnated and borrowing came in higher. Under the latest forecasts the national debt is set to peak at 81.1 per cent of GDP in 2015-16.

What does this mean for public spending?

The reduction in borrowing on this timetable comes at a serious price. The OBR notes that the Treasury is targeting a fall in total public sector spending to just 35 per cent of GDP in 2019-20. That would be its lowest share of GDP in some 80 years. But the squeeze on some areas of state activity would be even greater. Public sector day-to-day spending – which excludes welfare transfers such as the state pension and tax credits – will fall to just 14.1 per cent of GDP in 2017-18. And then the Treasury has pencilled in further declines so that the share falls to 12.6 per cent of GDP by the end of the decade.

An increasing number of analysts say that such a massive squeeze on public services – everything from the police to the army – will prove impossible for any government to deliver. Many say that taxes will have to rise to hit this target. Alternatively, the deficit could be closed over a longer period, which is what the Liberal Democrats and the Labour Party propose.