Saturday, December 07, 2013
A stronger growth forecast: now to beat it
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.

Set pieces like budgets and autumn statements are like selection boxes. There is a lot to choose from so you are tempted to try everything.

For George Osborne's fourth autumn statement, delivered on Thursday, there are many things I could dwell on, from measures to ease the burden on business - including rates - to action to encourage firms to take on young workers by abolishing employers’ National Insurance contributions for under-21s.

I could talk about fuel duty freezes that in a couple of years will be worth an average of £11 a tankful (compared with increases under the now-abandoned escalator) or the decision to hit foreign property owners with capital gains tax.

Let me, however, concentrate on just two aspects of the statement, the most important aspects: growth and the public finances. The upward revision to the Office for Budget Responsibility’s growth forecasts, taking this year up from 0.6% to 1.4%, was inevitable given the run of the quarterly gross domestic product numbers,

By normal standards, 1.4% growth would be a disappointing year and 2.4% - the OBR’s forecast for next year - merely middling. These are not, of course, normal times. Britain’s quarterly growth of 0.8% in the third quarter was good enough for a couple of hours to take Britain to the top of the G7 league, until an upward revision of America’s GDP figures took them to 0.9%.

Even so, the OBR’s upward revision of 2013 growth from 0.6% to 1.4% was, as Osborne pointed out, the biggest such in-year revision for 14 years. It also left room for further improvement.

Growth should exceed the new official forecasts of 2.4% in 2014 and just 2.2% in 2015. The OBR is quite cautious even in the short-term, predicting quarterly growth rates of just 0.5% through next year. There is scope for further pleasant surprises.

Not only would that be nice, it is essential. The striking thing about the economy over the past few years, which the OBR brings out well, is how much ground there is to make up. It is as if, five or six years ago, Britain went on a long detour, which has taken us a very long way from our destination. Indeed, we may never get there.

By the early part of 2019, according to the OBR’s new forecast, Britain’s gross domestic product (GDP) will be 15% larger than at the beginning of 2008, the eve of the 2008-9 recession. That does not sound bad, except 15% over 11 years averages out to little more than 1% a year.

That average is dragged down, plainly, by the economy’s 7.2% dive in 2008-9. But the big picture, of an economy hit extremely hard and only gradually getting back to its feet, remains even after last week’s upward revisions. Now contrast that, as the OBR does, with the economy as envisaged by the Treasury back in 2008. Projecting forward its assessment of trend growth, as the OBR does, gives you an economy 35% higher in 2019 than 2008.

The gap between the two estimates, nearly a fifth of GDP (roughly £300bn) explains why we do not just need growth, we need much stronger growth. Otherwise the damage that we suffered as a result of the crisis makes us permanently poorer.

Can it happen? Can we see a few growth numbers starting with a “3” rather than a 2? The answer is yes. The new official forecast assumes no export-led recovery. Through the period 2012-2018, the contribution of net exports to growth is negative.

Replacing that with a positive number would take us back to the kind of growth envisaged on the back of a competitive pound a few years ago, it would also help close the GDP gap. Some fear sterling’s recent revival will nip any export revival in the bud. It is a bit more complicated than that. Exports can do better.

Is there room for much faster growth? The OBR is downbeat on productivity and believes there is a relatively small amount of spare capacity in the economy, 2.2% of GDP. You do not know how much spare capacity you have until you reach its limit but that is too gloomy. In a service-based economy, capacity can be very flexible.

Let us hope so. It was the OBR’s gloomy supply-side view which, two years ago, pushed Osborne into abandoning his original hope of squeezing all the fiscal pain into a single parliament.

His measure of when the job was done - eliminating the so-called structural current budget deficit - was in June 2010 predicted to be achieved in the 2014-15 fiscal year. Now it will not be reached until 2017-18 and the path there is slightly slower than the OBR expected in March (stronger growth does not help cyclically-adjusted borrowing).

That may be no bad thing. Out of the adversity of a deficit taking longer to come down than he hoped, Osborne has forged an opportunity. Instead of a “Hey Presto” fiscal magician ready to hand over things over to the next set of politicians who want to spend taxpayers’ money, he has become a keeper of the Treasury keys, determined that his “responsible recovery” means responsible public finances.

So there will be an overall budget surplus by 2018-19, from a downward-revised (but still high) £111bn this year, which as the OBR says “suggests that underlying net borrowing will have fallen by 11.1% of GDP since 2009-10”. That, by the way, is equivalent to bringing the budget deficit down by £180bn. It may yet be that progress is a little quicker — I am still hoping for a deficit of less than £100bn this year.

There will be a strengthened Charter of Budget Responsibility, to be presented to parliament in a year’s time. There will be measures, notably bringing forward increases in the state pension age, to save significant sums in future (£500bn over 50 years in the case of pensions). And the government will aim for a budget surplus of 1% of GDP in the good years in the long term.

Politicians, and chancellors - including very political chancellors like this one - come and go. One extraordinary statistic from the OBR is that before the end of this decade, core government spending on services (excluding welfare, debt interest and other transfers) will be its lowest percentage of GDP since 1948.

The good news is that Osborne is trying to impose a discipline on spending that will tie the hands of him and his successors. The question is whether such constraints will be more effective than in the past. They need to be.