Sunday, June 13, 2010
As if by magic, Sir Alan reveals the true deficit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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Tomorrow, at 10am to be precise, something rather special will happen. For the first time the official forecast for Britain's economy will be produced by an independent body, the Office for Budget Responsibility (OBR).

The OBR, headed by Sir Alan Budd, assisted by Geoffrey Dicks and Graham Parker, is set to become almost as important an acronym as the MPC (the Bank of England's monetary policy committee). Budd may become the second most famous "Sir Alan" in Britain. He, rather than the chancellor, will be responsible for the forecast, breaking a decades-long tradition.

Though forecasts were around before the 1975 Industry Act, it was this that first required the Treasury to "keep a macro-economic model suitable for demonstrating the likely effects on economic events in the UK of different assumptions".

In case of misunderstandings, the act said the model should be on a computer pretty radical in those days made available to outside users, hence the Item (independent Treasury economic modellers) club. It also required the publication of a forecast "not less than twice a year".

Without digressing too much into history, it seems successive chancellors broke the law, for the act said they should present forecasts on the basis of alternative assumptions. Though there has been a bit of this in recent years, mostly chancellors have given us a single forecast.

Anyway, from tomorrow the forecasting task is the OBR's. There will be an 80-page report, "fan" charts to reflect the uncertainties and some commentary on the long-term sustainability of the public finances. It does not mean the Treasury model has been pensioned off after 35 years' service the new body has been using it and, indeed, has borrowed a team of Treasury officials to run it.

How scary will the OBR's pre-budget forecast be? David Cameron has been preparing us for something bloodcurdling, beginning in this newspaper last week. The most obvious change between the forecasts Alistair Darling presented in his pre-election budget and tomorrow's figures will be in the growth numbers.

The March budget predicted growth of between 3% and 3.5% next year, rising to 3.25% to 3.75% in 2012. Even the cautious assumptions used for the public finances were for growth to average 3.25% a year through to 2014-15. If that was cautious, you might wonder what they might have come up with if they had really let rip.

The OBR, as you might expect, is not leaking its predictions. It will be a surprise, however, if its growth forecasts, and the assumptions it uses for the public finances, do not have a "2" rather than a "3" in front of them for the forecast period. It may base its projections for the budget deficit on numbers up to a percentage point weaker, each year, than in March.

Does this mean the hole in the public finances will be even larger? Could Budd unnerve the markets by suggesting Britain's debt and deficit problems are not just formidable, but insurmountable?

On this, things are not all going in the wrong direction. The 2009-10 budget deficit, 156 billion, came in 11 billion lower than predicted in March. That lowers the starting point for future borrowing. On top of that, the government announced a net 5.7 billion of spending cuts for 2010-11, though they won't be included in the OBR's base-line projections.

The recent numbers may be testimony to something Treasury officials were keen to establish in the past couple of years, a "de-linking" of the borrowing and growth forecasts. The future fall in borrowing did not, in other words, stand or fall on over-optimistic growth assumptions. Tomorrow's projections should be bad but not dreadful.

That does not mean everything is hunky dory. John Hawksworth, head of macroeconomics at Price Waterhouse Coopers, expects that borrowing this year will be 155 billion, only just below last year's outturn, falling to 80 billion by 2014-15, 6 billion higher than the March projections.

Malcolm Barr of JP Morgan is a little more optimistic for this year, 145 billion, but expects the OBR to predict 72 billion in 2014-15, close to the existing forecast and not enough of a reduction for the new government, the markets or ratings agencies. The key will be what the OBR says about the "structural" deficit.

That is when things enter a second phase. After tomorrow, Budd and his team will have just a few days to assess whether the measures the chancellor intends for his June 22 budget mean there is a better than 50% chance of the government achieving its fiscal mandate.

Set out like that, it sounds very simple, except that the OBR does not yet know what the fiscal mandate is. Nor does it yet know the size of measures in the budget, which will include both tax changes and the spending totals for the next three years, to be filled in by hard bargaining over the summer and early autumn.

The coalition agreement between Conservatives and Liberal Democrats pledges to "significantly accelerate the reduction of the structural deficit over the course of a parliament" compared with Labour.

In theory, Budd could adjudicate on that basis, though applying a greater than 50% probability to an interpretation of the word "significantly" would be stretching it. He needs something more precise.

As for the budget measures, the new chancellor has promised his approach will change things, and he is right. Anybody who has witnessed budget-making and the last-minute battles, usually between 10 and 11 Downing Street, will know we are heading into a different era.

You could have the OBR team working late on budget eve, or a messenger delivering the final budget measures to a nightshirted Budd for him to do a quick analysis on the computer. I suspect, however, the new process means the budget will have to be settled several days before it is delivered. So, while setting up the OBR means the chancellor has voluntarily deprived himself of power, George Osborne should be more insulated than his predecessors from late changes to his budget by No.10.

What will Osborne tell the OBR? How nasty will the June 22 budget be? Rarely has so much effort been devoted to preparing people for the unpalatable, and chancellor and prime minister will not want to see it wasted. This is the one they think they can blame on their predecessors. I will have more to say next week on what it might be.

PS: I'm all for flattering our Canadian cousins by telling them the new government is basing its approach on their successful assault on the budget deficit in the 1990s. But we should also look at another example, with an identical political system and set of foibles to our own.

I'm talking about Britain, under chancellors Norman Lamont, Kenneth Clarke and Gordon Brown (the early version), also in the 1990s. Canada's achievement, in moving from a budget deficit of 9.1% of gross domestic product in 1992 to a surplus of 2.9% in 2000, was considerable. But Britain's performance, from a deficit of 8% of GDP in 1993 to a budget surplus of 3.7% in 2000 all on the basis of comparable OECD figures was just as good.

Canada achieved cuts of 20% in spending, but something similar happened in Britain, as a percentage of GDP. Public spending fell from 44% to 36%. The Canadian approach, of course, proved sustainable, while in Britain the return of the public finances to health provided the excuse for a splurge. Nonetheless, we should not forget what was achieved.

From The Sunday Times, June 13 2010