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A Political or Fiscal Coup? Political Management may be the first step for Structural Reform

Growth is the key. That remains the crux in the wake of this week’s Autumn Statement and Comprehensive Spending Review.

Yet, for the moment, the growth projections for the economy have been largely overshadowed by the independent Office for Budget Responsibility’s (OBR) upward revision to tax revenues and downward revision to debt interest rate payments, the net effect of which was to allow the Chancellor an extra £27 billion to play with over the next five years. This, along with increased taxes, for instance on firms through the apprenticeship levy and on second homes and through higher council tax, allowed the Chancellor to stick to his plans of a £10 billion budget surplus by the end of this Parliament. He was able to achieve this despite abandoning his cuts to tax credit, and easing the overall pace of the squeeze on public spending.

‘The economy still has some way to go to achieve balanced growth ….’
The independent OBR expects growth of 2.4 per cent this year and next, which seems sensible. Inflation remains low and the recovery is still dependent upon low interest rates. While the attention in the Statement was on reducing the government deficit, there is still a need to keep a close eye on borrowing in two other areas. One is in the household sector, where debts have fallen from 168 per cent of income to 144 per cent in recent years and the hope is that consumer spending is driven more by increased productivity driving higher wages, rather than consumption being boosted by increased borrowing, as in the past. The other is the economy has a high current account deficit, which means the UK continues to borrow from overseas. As a result, the economy still has some way to go to achieve balanced growth. That being said, if investment continues to recover, then growth may yet exceed the 2.3 per cent to 2.5 per cent that the OBR forecasts for later in the Parliament.

‘Only when we return to a surplus …[can inroads] be made into the national debt’
While stronger future growth would allow the budget deficit to fall at a faster pace, until then, as seen in the Spending Review, attention has to be focused on the relationship between higher taxes versus spending cuts and the size of the state. I believe that fiscal policy can and should be used in a counter cyclical way if needed, and also I have favoured borrowing at current low interest rates to fund infrastructure, particularly where the returns to the economy would be high. That being said, I support the Chancellor’s aim to achieve a budget surplus by the end of this Parliament. It is only when we return to a surplus that inroads can be made into the national debt.

‘…Whether the breakdown of spending is correct is still a debating point’
The focus should be both on the quality as well as the quantity of government spending. The Statement pointed to £4 trillion of public spending over the next five years, concentrated on health £608 billion, pensioners £556 billion, welfare £556 billion and education £302 billion. Non ring fenced areas may not have been cut as much as expected in the Review, but they are being squeezed hard. The Government is right to focus on the need to reform public services, but whether the breakdown of spending is correct, is still a debating point. It is also good that there is a renewed focus on the need to boost investment and infrastructure.

The Statement pointed out that house prices, in real terms after allowing for inflation, are 3 per cent below their pre crisis peak. Despite this, house prices and rentals still appear high. Although high rents affect many groups, it is a particular concern for younger people. The housing shortage, however, will take some time to address as it reflects a lack of building over much of the last four decades, and also now a growing population. The Statement announced measures to help first time buyers. What we need to see is a market response with large scale building. In the 1930s and 1960s there was large scale building, helped by easy planning controls. Overall, it is hard to disagree with the overall aim of higher wages, lower taxes, targeted welfare, reforming Whitehall and an increased focus on education, transport and housing. If anything, the issue with tax credits highlights the pressures faced by the working poor but at the same time the pressing need is to keep income taxes down, see wages rise and hope that housing costs are kept in check by increased future supply. A stronger recovery, though, is central to helping achieve this.

 

Dr Gerard Lyons

Dr Gerard Lyons is an international economist and Chief Economic Strategist at Netwealth Investments, having previously served as Chief Economic Adviser to Boris Johnson while he was Mayor of London. He was Co-Founder of Economists for Brexit and is co-author with Liam Halligan of Clean Brexit (Biteback, 2017). For Politeia he was co-author of Banking on Recovery: Towards an accountable, stable financial sector (2016).

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