Sunday, March 13, 2016
Osborne skates on thinner ice as Brexit fears hit growth
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


When George Osborne started thinking about his eighth budget a few weeks ago he probably knew that by the time March 16 came around the EU referendum battle would be in full swing. That did not, however, stop him pushing ahead with ambitious plans to reform the way pensions are taxed, with his preference for a wholesale switch to a so-called pension ISA (individual savings account).

We know now that this will not happen, or at least not this week. Fear of doing anything potentially unpopular in the run-up to the referendum, as changing the existing system of tax relief would have been, led to the plans being shelved. There had been murmurings from Tory MPs.

Chancellors are supposed to do unpopular things in the interests of the longer-term good of the country. Osborne is finding it difficult to do so, particularly since the election. We may look back on the 2010-15 coalition as a model of stable government, certainly in comparison with what has followed.

Tory MPs have discovered their power. It only takes 30 or so of them, sometimes less, to force a retreat. That, more than the chancellor’s political opponents, forced the U-turn on cuts to tax credits last November. Tory MPs, by voting against the government, helped defeat plans to relax Sunday trading laws. There is a gathering revolt against a fuel duty rise this week, a rise that is counted in the government’s fiscal calculations. With dozens of Tory MPs openly campaigning against the EU stance of the prime minister and chancellor, this is turning out to be a chaotic government.

Osborne is quite good at pulling rabbits out of the hat, even if often on closer examination they turn out to be tiny kittens, so do not discount the possibility of a populist surprise or two this week. Even if there are, however, the chancellor will not want to let the moment pass without issuing stark warnings against the dangers of a vote to leave the EU.

Saying anything that suggests leaving the EU will have negative consequences and that membership has benefited Britain is tricky territory, as Mark Carney discovered a few days ago. The Bank of England governor can look after himself but when faced with attacks by oddball Tory MPs and an out-of-control “big beast”, the former chancellor Lord Lawson, there must have been moments when he wished he was back in Ottawa.

Jacob Rees-Mogg, the Tory MP for North East Somerset, accused him of making “speculative” pro-EU comments that were “beneath the dignity” of the Bank. Peter Bone, his Wellingborough colleague, said Carney should consider his position and drew the contrast between the Bank governor and John Longworth, the “Brexit martyr” who resigned as chief executive of the British Chambers of Commerce (BCC) after speaking out at its annual conference.

MPs have sunk low in recent years but this really was scraping the barrel. Carney was not speculating but accurately reflecting the view of his institution, as set out in its carefully-researched report last October, EU Membership and the Bank of England, which provided extensive evidence that trade openness with the EU, inward investment to access the single market and free movement of labour “reinforces the dynamism of the UK economy”. Longworth, in contrast, deliberately went against the agreed position of the BCC, the organisation he was paid to run.

Lord Lawson was even worse. Suggesting in a BBC interview that Carney was driven by the desire to curry favour with Goldman Sachs, his former employer, and get a good job there when he steps down from the Bank, was beneath the dignity of a former holder of the office of chancellor.

Fortunately for Osborne, one accusation that was levelled at Carney, that he was guilty of wading into politics, cannot be legitimately directed at him. The chancellor is meant to be knee-deep in politics, though sometimes he is up to his neck in it.

The chancellor has promised a full Treasury analysis of the costs and benefits of leaving versus staying in the EU, though the only guidance on timing is that it will be published between now and the referendum. One thing that would help frame the debate, an Office for Budget Responsibility forecast showing the outlook for the economy and the public finances on “In” and “Out” is, officials say, outside the OBR’s terms of reference. It can only forecast on the basis of government policy, which is to stay in the EU.

It is, however, generally accepted that Brexit would be a negative shock for the economy. The long-term consequences or leaving can be debated. In the short-term it would, as the prime minister put it in a speech last week, cost growth and jobs.

As a report last month, London: The Global Powerhouse, commissioned by Boris Johnson, the pro-Brexit mayor of London, put it: “Leaving the EU would be an economic shock. Most, if not all, economic shocks depress economic activity. Thus economic forecasts that focus on, say, a couple of years ahead would tend to show that leaving the EU is always worse than the alternative.”

How big a short-term negative shock might there be? Kevin Daly, UK economist at the aforementioned Goldman Sachs, says that there would be “a damaging uncertainty shock for the UK” which could be prolonged. “Business investment accounts for 10% of UK GDP,” he writes in a special report. “A collective decision to pause a significant share of this spending would be materially negative for UK output.”

ABN-Amro, another investment bank, says Brexit would push Britain’s GDP down by between 1% and 3% next year. An effect at the upper end of that range would push the economy back into recession. Societe Generale, in a new report, says Britain’s growth would be reduced by between 0.5% and 1% for a period of 10 years.

A bigger concern than these effects on GDP, which can never be precisely measured, would be if things really got out of control. That is why Carney announced measures to see the financial system through a Brexit shock, if it occurred. Even that might not be enough. Berenberg Bank warns that a crisis in the second half of the year would follow a vote to leave. Neil Williams, chief economist at Hermes, the investment managers, thinks the Bank of England would be forced into another round of quantitative easing, last undertaken four years ago.

This is where it gets interesting, and where useful anti-leave ammunition for Osborne could turn into something more dangerous. The public finances, as the chancellor often reminds us, are still not fixed. He is likely to announce further action this week to restrain spending over the medium-term.

Even without a Brexit vote he is heading for a £50bn borrowing overshoot over the next five years compared with the OBR’s November forecast, according to a new analysis published today by PWC. It will not be surprising, given the downward revision of so-c alled nominal GDP since November, if the OBR has presented the Treasury with similar numbers.

With Brexit, borrowing could easily shoot up to more than £100bn annually, creating powerful echoes of the crisis of a few years ago, and fatally undermining Osborne’s efforts to restore the country to fiscal health.

The chancellor has been steering a fine line between keeping the markets and international investors happy with deficit reduction and not killing the recovery with excessive austerity. A Brexit vote, or even the heightened fear of it, could mean that he has been skating on very thin ice.