Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 18 March 2015

A productive budget?

What exactly was George Osborne trying to achieve in his budget? Janan Ganesh says “To his gut, he worries about debt.” But if reducing the deficit and debt really was his number one priority, then why spend £5.7 billion over five years increasing the income tax personal allowance, give £3 billion away to savers, and add a £2.2 billion subsidy for first time house buyers? It is true that these giveaways were matched, in theory, by various ‘takeaways’ (mainly a £4.4 billion increase in the bank levy), but if getting the deficit down was the priority, he could have done the takeaways without the giveaways.

Everyone knows the answer of course. Winning the next election is much nearer Osborne’s gut than worries about debt. [1] Much has been made of Labour’s alleged core vote strategy, but what this and earlier budgets suggest is that the Conservatives have been following a core vote strategy. There are income tax cuts that mainly benefit the well off, bribes or tax breaks for the elderly with large savings or pensions, and measures to help those expecting to buy a house (and consequently those planning to sell them their house). Why do commentators complain about a core vote strategy for Labour but not the Conservatives? I’ll leave that as an exercise for the reader.

The Chancellor could not give away more because he needed to maintain the image of prudence. The sharp cuts in spending after the election remain: to quote the OBR: “a much sharper squeeze on real spending in 2016-17 and 2017-18 than anything seen over the past five years”. With the OBR predicting interest rates will be very close to their lower bound over that period, this still amounts to taking a big risk with the economy. [2] He was unlucky the last time he tried this in 2010 (and we are on average at least £1,500 poorer as a result), so I guess he hopes he will get lucky this time.

Is this all because of worries about debt, at a time when interest rates on debt are very low, and the chances of a debt funding crisis are non-existent? Even the Economist now suggests that maybe the terrible performance of UK productivity over the last five years might be a rather more important issue to focus on. Anna Valero and Isabelle Roland have a nice LSE briefing paper on this, from which this figure is taken.


The good news is that UK productivity growth has been relatively strong from 1979 to 2008, perhaps partly because we had some catching up to do. The bad news is that from 2008 it has been a disaster. Yet the word ‘productivity’ does not appear in the Budget speech. There are of course small measures here and there that could be filed under ‘improving productivity’, but it is, as Frances Coppola notes, peanuts compared to both the size of the problem and the cuts to public investment undertaken in the first few years of this government. The LSE paper has some interesting things to say about the UK’s productivity gap with other countries (poor investment, low firm and government R&D expenditure, poor management quality), and is fairly critical of the Coalition government’s policies that could influence this.

It is fairly easy to make fun of Osborne’s references to his ‘long term plan’, and it is tempting to conclude that the frequent repetition of the phrase means there actually isn’t one. But perhaps it is all very simple. In this piece for The Conversation I suggest that maybe there has been a clear plan all along: to reduce the size of the state over a ten year period, using the deficit as cover. Here is a chart from the OBR’s forecast document showing the projected share of government consumption in GDP.


One of the more absurd features of the budget is the kick up in spending pencilled in for the final year, which appeared to be designed only to avoid the Labour jibe that we were going back to the 1930s. Otherwise, the idea is to fundamentally reduce the size of the state, and so far it is going to plan. To finish the job, the Conservatives need to get re-elected, and that required easing up on austerity from 2012 onwards by either cutting taxes or not raising them to achieve the original targets. If this is the real long term plan, then there is no reason to believe that we will not get the promised second period of severe spending cuts once the Conservatives have won the election, with of course tax cuts later on to make it all seem worthwhile.

From this perspective, the criticism that Osborne is ignoring the productivity issue may also be unfair. The Conservatives may genuinely believe that the best way of increasing productivity is to reduce the size of the state, and get the ‘government off the backs’ of private enterprise. This theory does not look too good just now, but I guess the lags on this may be long. Alternatively, of course, they may have got completely the wrong idea about the role that government needs to play in encouraging growth generally and innovation in particular.


[1] Am I right to assume that these tax giveaways are essentially political? Take the increase in the personal allowance for example. The IFS suggest that aligning the employee national insurance threshold with the income tax personal allowance would be a better policy than raising the income tax threshold, both on distributional grounds (it benefits around 4.6 million low paid workers who pay no income tax), and in terms of work incentives (as it applies only to earned income). On the Help to Buy ISA, see John McDermott in the FT.  

[2] In passing, it is worth noting that the OBR are also forecasting inflation coming back to 2%  - by 2019! This is despite a view that the current output gap is pretty small. Some of the capacity utilisation indicators that go into that estimate do look very strange (tables 3.2 and 3.3).  


15 comments:

  1. Nice post - I particularly like the inclusion of the productivity chart; it's pretty clear to all the UK has a problem there. So what are the Govt doing? Stimulating an already buoyant savings ratio with pre-election savings giveaways. That's really going to affect productivity - not. The problem with bribing the electorate is that it works... even though as a result less of Britain will afterwards.

    By the way, nice updated pic and link to your excellent CV! Fascinating reading. :-)

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  2. Osborne may worry about public debt, but he says little about private debt. Chart 3.31 of the latest OBR outlook shows the household gross debt to income ratio rising steadily over the next 5 years, to be above the pre-crisis levels by 2020. Public debt bad, private debt good, apparently.

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    1. On the other hand interest rates have steadily declined over the last twenty years or so. I would expect an effect of that to be a rise in lending of all sorts. I have no objections to debt as such, as long as the debtor can easily afford the interest and eventual repayment of capital.

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  3. In addition to taking the p*ss out of Osborne’s phrase “long term plan”, we also need to take the p*ss out of his phrase “Northern powerhouse”. The latter catchy little phrase refers to his plan to spend a bit more on infrastructure in the North, which is hilarious when you consider that in recent years, government has spent 24 times as much per head on transport infrastructure in the South East as in the North. See:
    http://www.theguardian.com/news/datablog/2014/aug/07/london-gets-24-times-as-much-infrastructure-north-east-england

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  4. "perhaps partly because we had some catching up to do"

    Can you explain that aside?

    Most economic historians argue that supply-side reforms under the "small state" Tories in the 1980s raised living standards and reversed the UK's relative decline. You argued this yourself in your piece on Thatcher.

    What makes you believe that this time is different? That an entrenchment of "big state" structural reform, e.g. a la Mazzucato, is going to work better than it did in the 1950s-70s era?

    G/GDP is obviously a poor proxy for the extent of interventionism, and outside perhaps of education it is hard to think of any major goods, service, or labour market liberalisation under the Coalition. RM privatisation, maybe? The significant Coalition initiatives on the housing market sit firmly in the mould of Blair/Brown "big state", hardly a libertarian fantasy: tinker at the edges of supply (planning), pour gasoline on the demand-side fire (HTB etc).

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    1. In terms of international productivity comparisons the UK at the end of the 1970s was well behind, and we needed to catch up. Over the next 40 years we did to some extent, both under the Conservatives and Labour. This argues against any simple linkage between small states and productivity.

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  5. OK, so what should the government do to increase productivity?

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    1. my suggestion on improving education in the long term is to invest in children and ensure their health and education are great, for all children. As to short term, maybe the Tories should try a stimulus, and once the economy is doing well, they can decide on how large a state they want.

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    2. "What should the government do to increase productivity?"

      The most obvious thing - and I'm frankly amazed this is not said more often - would be to avoid subsidising labour. It seems axiomatic that any subsidy to a factor of production will, ceteris paribus, lead to an over use of that factor and a decline in its productivity. So all wage subsidy schemes both explicit - Earned Income Tax Credit, apprenticeship subsidies - and implicit (restrictions on collective bargaining, increases in retirement age, below-inflation increases in the minimum wage - will tend to lower productivity.

      Now the argument is obviously that we need to get people in work for the societal benefits of working rather than not, and there's a case for that. But that case rather falls down when people are having to work at two or more jobs, not retire or otherwise enter sub-optimal relationships because they are not earning or receiving enough to live on otherwise.

      To listen to the government, you would think that the purpose of economic policy is to enable more people to work for less so that we don't have time to do anything else. That's not my dream and I don't think it should be our society's dream either.

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    3. The LSE briefing paper that I linked to has some good points on this.

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    4. It does indeed, an interesting read, thanks for pointing that out, though I am a little surprised that it doesn't say much about education or construction/planning policy (presumably because its focus is medium term while these are long term factors).

      At any rate, it is clear what the challenge for a second term for the Coalition should be!

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    5. Job guarantee. Take labour away at the living wage. Then businesses will innovate and automate.
      Also we don't waste a huge amount of people unemployed. Examples of work to do e.g. environmental, high labour/low skill work like sand dune stabilisation, river valley erosion, cleanups, free childcare, translators, help immigrants integrate, allotment management etc. Could be done at local level.

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  6. The Conservative Party, the written press, and BBC Radio Four's Today programme all have the similar problem that their voters-readers-listeners fall disproportionately into a similar upper age bracket, which is presumably why to this thirty-three year old they together seem to have created a shared black top tabloid way of presenting 'economics' that bears no resemblance to the adequate scrutiny of economics issues and have become to a greater or lesser extent the home of some pretty predatory ways of presenting their so-called economic issues to this (is 'groomed' too strong an adjective?) gerontocracy.

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  7. The "productivity catching up" all seems to have happened after the 1992 devaluation. coincidence or something more sinister?

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  8. "add a £2.2 billion subsidy for first time house buyers? "
    It is not a subsidy to buyers. It is to sellers as house (land) prices will rise by that amount. Far better for first time buyers is 100% land value tax, where you effectively rent the "location, location, location" part to the govt and don't pay income tax, NI, etc.

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