Sunday, April 19, 2015
Parties obsess about "costings", while ignoring the elephants in the room
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.

I would not want anybody to think a theme is developing here but, having warned last week that we should take economists’ views on austerity with a pinch of salt, this week I have another warning about this kind of thing.

When you see the words “fully funded” or “properly costed” attached to the plans of political parties, take great care.

Be also sceptical about fake precision. I know why it made the headlines but the difference between an International Monetary Fund forecast that there would still be budget deficit of £7bn in 2020 and the Office for Budget Responsibility’s prediction of a £7bn surplus is margin of error territory.

The IMF predicts a deficit of 0.3% of gross domestic product in five years’ time, the OBR a surplus of a similar amount. This is small change, even when you factor in the possibility that we may have a government in place which is not even aiming to eliminate the overall budget deficit.

The IMF produces its fiscal monitor every six months. The 0.6% of GDP difference between it and the OBR’s projections is not untypical of the size of the IMF’s six-monthly forecast revisions for Britain’s deficit –in either direction – not for five years’ time but for the coming year. Until they have quite a lot of monthly data to go on, forecasters struggle to get within £10bn of the deficit for the current fiscal year, let alone what it will be in 2020. The difference between a small surplus and a small deficit in five years is, as the IMF managing director Christine Lagarde has pointed out, fake precision.

This is not to say that we should just allow the political parties to say what they like, without any nod in the direction of fiscal reality. This may be good enough for those at the fantasy end of the spectrum, like the Greens and the Scottish Nationalists, but neither are going to form a government and, it is to be hoped, will have little influence on the government that is formed.

But there is also a danger in going too far the other way, in which the parties fight over a tiny amount of fiscal territory, ignoring what really matters. In this environment, the political accountants take over. So Labour was keen to show that, as Ed Balls put it: “Every policy fully costed, fully funded, fully paid for with no additional borrowing.”

The Tories followed suit with some things, explaining how they would pay for raising the inheritance tax threshold on homes to £1m and enhanced childcare (reducing pension tax relief for £150,000-plus earners) and the right to buy programme for social housing tenants (sell expensive council properties), while not spelling out how they would pay for £8bn of extra health spending, or how they would fund raising the personal allowance and higher rate threshold.

A looser approach has something to be said for it when you look at some of what else is on offer. So Ukip accompanied its manifesto with a costing exercise produced by the Centre for Economics and Business Research.

The CEBR dutifully looked at the savings from reducing overseas aid, cancelling HS2, the absence of EU contributions (when Britain exits) and scrapping the Barnett formula, and set them against the cost of Ukip’s proposals, including income tax cuts and the abolition of inheritance tax.

What it could not look at, however, was the elephant in the room. What would be the effect on the economy, and on the public finances, of Britain leaving the EU? I cannot tell you precisely what that effect would be, but it would be bigger than all Ukip’s measures combined and overwhelmingly negative for growth and tax revenues, at least in the early years. It is the elephant in the room.

There are other elephants. In December the OBR set out three different scenarios for the economy and the public finances, based on what it described as low and high assumptions for productivity – output per worker - alongside its central forecast or some recovery in productivity growth.

The differences were striking. If productivity growth stays low, essentially the deficit stays high, and government debt rises. But in a high productivity scenario, growth is stronger, the deficit comes down more sharply, and debt falls smartly as a percentage of GDP. The differences were enormous. On a high productivity scenario debt at the end of the decade would be more than £600bn lower than if productivity is weak.

But, while we should be sceptical about the ability of governments to wave magic wands and boost productivity, have we heard anything in this campaign on this subject which is remotely convincing?

Or, when it comes to the outlook for the public finances for the next few years, the oil price is hugely important. In March 2014 the OBR expected the oil price to average $100 a barrel over the next five years. Now it expects $70 a barrel.

The drop in prices was the equivalent of a tax cut that no government could have afforded. As the Ernst & Young Item Club will say in its new forecast, to be published this week, the boost to real incomes from cheap oil, weak commodity prices and supermarket price wars will trump political uncertainty as far as the economy’s performance this year is concerned. If the oil price were to rise, reversing that effect, growth would suffer, and vice versa.

To a certain extent I am saying that Harold Macmillan’s “events, dear boy, events” are more important influences than the relatively things the political parties are arguing, and often deliberately obfuscating, about but there is more to it than that.

What matters is the supply-side of Britain’s economy can be invigorated, delivering the productivity growth that would reduce the need for further fiscal pain and put government debt on a decisive downward track. Labour has proposals that for the most part would damage the supply-side by increasing government intervention, reducing Britain’s appeal to inward investors and making the labour market more flexible.

But the Tories, as noted, have done little to suggest they have taken hold of the productivity issue. And they worry many people in business with the fear, though it is exaggerated, that they will take Britain out of the EU, and by worries that they will indeed clamp down in immigration. For many in business, this is a Tory policy they hope continues to fail.

Maybe there are no votes in the supply-side, when set against the “fully costed” promises the politicians matter. But it is the supply-side rather than those which will determine our future prosperity.