Sunday, November 27, 2011
Osborne faces struggle to stay on the road
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

There will be surprises in Tuesday's autumn statement; there always are. The full picture will only become clear on the day.

Nevertheless, some things can usefully be said. Gratifyingly, some of the things I have been banging on about here in recent weeks and months will see the light of day.

So, proposals to launch a “credit easing” plan for small and medium-sized firms, are a direct response to the recovery-destroying fall in lending to this vital sector of the economy, which has been happening for the past three years.

The plan will draw upon the success of Germany’s KfW (Kreditanstalt für Wiederaufbau) and an existing European Investment Bank model, the government using its credit rating to access funds at low rates, which will be channelled through the banks to smaller firms. The scheme will not provide a full solution to the lending famine but is a step in the right direction.

The other is that, having denied it would do so, the Treasury has relented on capital spending. A feature of the spending plans the coalition inherited from Labour, to the extent they were detailed, was the savage cut in publicly-funded capital projects.

My suggestion was that the government should use the savings on debt interest (from low gilt yields) and by trimming some current spending to boost capital spending. That will happen, a £600m building programme for new free schools being one element of it.

The bigger long-term prize, tapping into the vast billions in pension and insurance company funds to privately finance much higher levels of infrastructure spending is also creaking into action and memorandums of understanding are being signed.

As well as these, we had the housing strategy, of which more below. Vince Cable, business secretary, unveiled what his department describes as the most radical employment law reform in decades, including an overhaul of employment tribunals and easing unfair dismissal rules. Nick Clegg, the deputy prime minister, gave us a £1 billion employment and training subsidy for young people.

Why the flurry of pre-announcements and well informed leaks? One possibility is that the chancellor has something so big to announce on tax on Tuesday that the decks had to be cleared. Some accountants have been warning of a tax shake-up, though the Treasury has been guiding against it.

The other is that the government expects this week to be so dominated by the Office for Budget Responsibility’s (OBR) downgrade of growth, and its expected warning that the fiscal rules are at greater risk of being broken, it might as well get some coverage for these other announcements while it can.

In March the OBR predicted 1.7% growth this year, followed by 2.5% in 2012. Both numbers now look too high; the consensus in new independent forecasts is 1% in each of the two years.

Though there are unlikely to be any surprises in the OBR’s forecasts, they will attract plenty of critical headlines. A gloomy forecast tomorrow from the Organisation for Economic Co-operation and Development will set the scene.

Though it has not happened yet, independent economists expect slower growth to impact on the public finances with the average forecast for public borrowing next year, 2012-13, £112 billion, against the OBR’s March prediction of £101 billion.

Carl Emmerson, deputy director of the Institute for Fiscal Studies, expects the OBR to say there is a better-than-even chance of balancing the current budget deficit (adjusted for the cycle) in 2016-17, the new target year, and for debt to be falling as a percentage of GDP by the end of the parliament.

John Hawksworth and his colleagues at Price Waterhouse Coopers sketch out three scenarios. In PWC’s main scenario, with a couple of years of 1% growth, followed by a pick-up, Osborne meets his rules; and does so comfortably in its optimistic scenario.

Only in PWC’s pessimistic scenario, in which the economy goes back into recession next year - a flavour of which we may get from the OECD - are the targets missed badly. Though the deficit goal is cyclically adjusted, a recession would knock it off track. Debt would be rising as a percentage of GDP by the parliament’s end.

The economics of this sound dry but the politics of such an outcome would be explosive. Even viewed in the light of PWC’s main scenario, Britain’s public finances remain in a poor state, though we should not ignore the fact that progress has been made.

It seems longer, but it was only two years ago we were waiting for Alistair Darling’s final pre-budget report. The budget deficit was going from unbelievably awful to completely disastrous. Darling said it would be £178 billion in 2009-10, falling only slightly to £176 billion in 2010-11, before dropping to £140 billion this year, 2011-12.

Though growth has been weaker than the Treasury expected, the deficit has been lower: £156 billion in 2009-10, £137 billion in 2010-11 and it appears to be on course for £122 billion (the OBR forecast) this year.

Over three years borrowing is expected to be nearly £80 billion less than predicted two years ago. Partly that is coalition policies. Mainly it is due to the tendency of economists to underestimate the scope for the public finances to improve in a growing economy.

There, of course, is the rub. For all the flurry of activity, there is not much the government can do about growth in the short-term, and I can predict with confidence two things that will happen on Tuesday.

The Plan B brigade will urge a fiscal stimulus, despite the OBR’s view that there is zero room for manoeuvre. After years when the consensus was that fiscal fine-tuning did not work, it is suddenly regarded by its proponents as the greatest thing since sliced bread. It never was.

The other predictable response will be from Britain’s equivalent of America’s Tea Party, young men of the right, who will criticise Osborne for presiding over a rise in debt. In March, to their horror, the OBR predicted a rise in public sector net debt from £909 billion in 2010-11 to £1,359 billion in 2015-16. This week’s figure will be higher.

This, however, is the way it has to be. You cannot go from a deficit of £156 billion, 11% of GDP, to zero overnight and it is economic illiteracy — of the kind that caused America’s debt deadlock in August — to suggest you can. Borrowing is being reduced; the most you can do on debt is slow its rise.