26 November 2020
Rishi’ s Economic Cold Shower
Will the out-turn really be that bad?
By Frank O’Nomics
Just when we were all getting excited about vaccines and the prospect of a return to normality, up pops Rishi Sunak to give us a stark reality check. Rarely has a Chancellor given away so much with such a sombre turn of phrase. The latest spending review has set out in the bleakest possible manner the prospective size of the bill for the measures taken to address the economic impact of the pandemic – surely by way of softening us up for the tax rises that must inevitably follow. But wait. Could a politician finally have learnt the benefits of under-promise and over delivery? Could he also be using the fear factor to bring in policies that would be unpopular in more normal circumstances?
The Chancellor of the Exchequer’s spending review was quite clear in telling us that the increase in borrowing needed to counter the effects of the pandemic will carry on well beyond this fiscal year. The £280bn already spent is expected to increase to £394bn, representing 19% of GDP – the highest level other than in wartime. The most chilling part of the statement was the extent to which excess borrowing will continue, with the number still as high as £100bn (against a £60bn figure forecast in March) in 5 years time. These numbers are a product of the Office for Budget Responsibility forecasting the biggest economic decline for over 300 years (the big freeze of 1709 since you ask), with the economy shrinking 11.3% this year and not getting back to pre-crisis levels before 2025.
So will the outturn really be that bad? Clearly the answer is not easy, not least because we still have the uncertainty of Brexit negotiations (the OBR suggest that no deal would create a further 2% fall in the size of our economy). However, the optimists amongst us might wish to look at the measures that the Chancellor announced to find some solace. Take for example the £4bn “leveling up fund”, which will pay for the upgrading of local infrastructure (such as bypasses) across the UK. This is good old-fashioned Keynesian economics. Spending on public works should have a relatively high multiplier (the people in receipt of the money spend a high proportion of it, helping a virtuous spiral). Similar effects will come from the £4bn of spending on prisons, £18bn on covid testing, PPE and vaccines, a further £6bn on health and £2.2bn on schools. The overall multiplier effect of this spending could generate taxes that help reduce those longer term borrowing estimates significantly and lead to better than forecast growth.
Ah, but what about those gloomy unemployment forecasts? The OBR expects unemployment to rise from 4.8% to 7.5% by the middle of next year, generating significant costs to support those out of work. There are two key points here. The first is that the OBR and the Bank of England have been way off the mark to date in predicting unemployment levels. This may be due to the underlying flexibility of the UK labour market or the effects of the furlough scheme, but the other factor to bear in mind is that the Chancellor has taken further steps to counter the ongoing impact. £4.6bn to help people back to work, targeting both the young and the long-term unemployed can make a significant difference.
The OBR is of course an independent body, but their innate caution has been very helpful for the government for a number of reasons. First, it has helped to soften up the electorate to expect some renewed austerity. The lack of a pay rise for 1.3 million public sector workers might usually be expected to result in a wave of strikes. This is less likely to be the case if a significant rise in unemployment has been forecast. Similarly, the (supposedly) temporary reduction in overseas aid, which will save £4bn, might have been difficult to get past Tory backbenchers if the economic forecasts were more optimistic.
Put simply, if the economy really does shrink as much as 11.3% this year, it seems hard to believe that the bounce back will only be 5.5% next year and 6.6% in 2022, particularly given the speed with which the vaccines are expected to be rolled out. The budget deficit is the difference between 2 exceptionally large numbers, and historically, once it starts to move in one direction it progresses a lot quicker than any official bodies manage to forecast. It is too early to think about starting to pay the bill, but the bleak economic forecasts will allow the government to look at measures such as capital gains tax reform and the equalisation of the tax rate applied to pension contributions next year. This, added to a higher than expected tax take if growth exceeds expectations, could help start to balance the budget a lot quicker than forecast. All of which would make the Chancellor look very clever.
