24 April 2016
Pointless: The problem with Budgets
by Frank O’Nomics
Problem singular? Why stop at one? ” Surely there are myriad issues that make the whole UK Budget process an exercise in futility?”, I hear you ask. You have a fair point and could start with the general issue that Budgets are driven by the electoral cycle, determined to get government support to a peak just in time for the next election, rather than by the economic cycle which would logically be the more important driver if the greater good prevailed. You could also, with some considerable recent justification, argue that we have just too many Budgets. Not only due we have tinkering in the Autumn Statement in November as well the usual March Budget, recent governments seem compelled to announce mini-Budgets after key events such as elections. Thus. we have effectively had 4 Budgets in the last 12 months, making George Osborne more of a “tinkerman” than Claudio Ranieri (the Chelsea rather than Leicester version).
We could easily extend this list of problems, and many would want to assert that the most recent Budget was merely marking time, trying not to upset anyone ahead of the Brexit vote on 23rd June (they appear to have failed), but I would argue that, at the heart of the Budget futility debate, lies the issue of economic data. There is no shortage of data on which the government can base its forecasts and policy adjustments, but the problem is that this data is both of a very poor quality (current statistics were designed over fifty years ago when the economy was dominated by goods rather than services) and is subject to endless revision. This latter point is key as it means that often the Chancellor seems to announce policies that are inappropriate for the true underlying state of the economy and the outlook for public finances, only to correct the situation at a point which is inevitably too late.
The most recent Budget highlighted two areas where revisions to economic data had a profound effect on official projections of the size of the deficit and hence on the measures that Mr Osborne had to announce to be able to meet his fiscal rules. Firstly, the Office for National Statistics revised down the overall size of the economy which meant that, given that this is what the Chancellor measures his cumulative debt against, he is likely to miss his fiscal targets without cutting spending. Secondly, the Office for Budget Responsibility lowered the prospective growth rate of the economy (by 0.4% this year and 0.3% next year), also a key factor for the Treasury in working out how much tax revenue will be generated and hence how much latitude they have over public spending. The big problem for the OBR seems to be the level of productivity growth, which appears to have taken a dive at the end of last year.
These factors meant that the Chancellor had to find a further £19bn to meet his fiscal objectives which, despite being helped by lower interest rate costs, has meant more painful cuts in departmental budgets, most notably in welfare spending (albeit briefly!). A great deal of accounting legerdemain (by moving capital spending forward and corporation tax back) would appear to have gone into creating a set of new Budget projections that still leave the numbers improving just in time for the next election.
Whether the measures announced in the Budget are overly prudent or too optimistic will be down to how accurate the historic and prospective data are, and there seems good cause to suggest that both will be questionable. The Budget consists of trying to balance two very large numbers, tax receipts on the one side and government spending on the other (both in excess of £700 billion per annum), and it does not take much of a change on either side for the movement in the deficit to be very large. This movement tends to have a certain momentum to it, and once it deteriorates can often be much larger than expected. Total government debt is up 50% since 2010 (to over £1.5 trillion). It is expected to continue to rise over the next 3 years, and this rise will be greater than forecast if growth is less than expected.
Trying to isolate the problems in the data is very difficult but taking the first issue above – measuring the size of the economy – economists have always struggled with which measure of GDP to use. There are 3: output, expenditure and income, all of which produce different results and are subject to revision over time. The second issue, that of productivity, is even more problematic, particularly for an economy such as ours which is so heavily based on services, and there has been an inability to properly capture new areas of commerce generated by the likes of Amazon Marketplace, Airbnb and Spotify. Productivity is usually taken as the amount of production generated per hour of work. A fall in productivity (or a lower than expected increase) will impact on economic growth, labour income, company profits and hence the government’s tax revenues.
The lower than expected productivity in the UK has been a major conundrum for the UK Treasury for some years, and is partly put down to the fact that UK companies tend to have more flexible labour conditions, which mean that hours are reduced rather than the workforce in times of economic stress (so lower productivity is the pay-off for the continued high level of UK employment). Stephen Nickell at the OBR has warned that the threat to the UK finances comes not so much from a global slowdown, but further lack-lustre productivity growth.
The problems with the data have not gone unrecognised and there are efforts to address them. Earlier this month, former Bank of England Deputy Governor Professor Charles Bean produced an Independent Report of UK Economic Statistics, which was prompted by “the growing difficulty of measuring output and productivity accurately in a modern, dynamic and increasingly diverse and digital economy”, as well as “a perception that ONS was not making full use of new data sources”. The review has incorporated a wide range of responses and it is clear that users of statistics believe that the ONS performance has deteriorated. The good news is that the review has come up with a range of recommendations to ensure that the ONS becomes fit for purpose, including their becoming more innovative in exploiting alternative sources of information. The report recommends the setting up of a data science hub to allow better use of big data. This will take some time and will never be perfect, particularly when it comes to measuring GDP, where some revisions will be inevitable due to the gradual accumulation of information, but at least it may mean that we will require fewer Budgets and will hopefully see less tinkering from one to the other.
In the meantime, be aware that the Budget forecasts were “predicated on the UK remaining within the European Union”, so if “vote leave” triumph then we should expect yet another Budget (but perhaps a different Chancellor), and we will have to put up with an extension to a renown TV franchise; we have had “Pointless” and “Pointless Celebrities”, and now “Pointless Economics”.
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