Hamish McRae: The long view says the cuts are not deep enough

My instinct is that the OBR's growth forecasts will probably turn out to be OK but that they are too optimistic about tax revenue

Tuesday 30 November 2010 01:00

More growth this year, less next. Fewer public-sector job losses, but still a huge number of them. A better-than-evens chance of stopping the deficit rising by 2015. And so on.

On the one hand the new economic forecasts from the Office for Budgetary Responsibility, understandably welcomed by George Osborne, confirm the fact that the economic outlook has improved just so slightly since June. It is a thorough piece of work, sensible, restrained and as likely to be right as any economic forecasts are these days. But there is something more. It is the way the OBR has started to look beyond this coming growth phase, beyond even the present generation of voters and taxpayers, to how public finances might develop over the next 40 years, and hence to the sort of decisions we will have to make about the entire role of the public sector.

The message, in a nutshell, is that the tough tax and spending decisions fix public finances for now but they are not tough enough to create a tax/spending balance that will be sustainable in the longer term.

Economic forecasts will always be wrong as to detail, so the first question is whether the new OBR forecasts are right as to substance. The twin central propositions of both the OBR and the Chancellor are, first, that there will be enough growth in the private sector over the next four or five years to more than offset the decline in the size of the public sector, and second, that the growth in revenues that will result from this, coupled with cuts in spending, will be enough to stop the debt rising still further.

Those propositions look reasonable enough, though it does not mean they will turn out to be right. The UK has an unusually open economy: we import a huge amount and, adding services with goods, we export a huge proportion of our output. The background against which we do this changes by the month. A short while ago it looked as though Ireland would not need an EU rescue. Well, we know what happened there, though most of us probably did not appreciate that it is a bigger market for UK exports than the four largest emerging economies combined: China, India, Brazil and Russia. By contrast, Germany, long a great exporter but not a strong importer, is becoming a much better market for us. A few months ago the US was recovering fast; now growth there has slackened.

But the big assumption – that the world is in the early stages of a sustained cyclical recovery – seems sensible. If that is right, then the plan to correct the deficit will turn out to be more or less right too. The fashionable criticism is that the OBR and the Government are too optimistic about growth. My instinct is their growth forecasts will probably turn out to be OK but they are too optimistic about tax revenue.

There are, however, two other huge issues. One is the economic cycle, the other these long-term predictions for public debt.

On the first there is almost a conspiracy of silence. We know that there will at some stage in the future be another recession. We cannot predict the timing or the depth but if past experience is any guide, this growth phase will peter out some time between 2017 and 2020. If we are not careful we – and the rest of the developed world – will go into that recession before we have got our finances under control. Remember, in 2015 the UK will have double the debt, relative to GDP, as it had in 2008. Maybe it is asking too much of the OBR and the Chancellor to admit there is such a thing as the global economic cycle, but I'm afraid there is.

On the second issue, however, the OBR is helpful. It has sketched out what might happen to public borrowing if you adjust for a shrinking workforce having to pay for the pensions and healthcare of a rising army of elderly people. Instead of the deficit steadily shrinking beyond 2015, it falls for a bit then starts to rise again from around 2024 onwards. A long way away? Not really: it is not much further in the future than Tony Blair becoming PM was in the past.

Or Gordon Brown becoming Chancellor. As he repeatedly said, public finances had to be sustainable in the long term. He was right, wasn't he?

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