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).