November 2017 Budget: Tinkering rather than Transforming

The big story behind the November 2015 Budget is the absence of a big story. If our economy was doing very nicely with no major problems then minor measures here and there would be fine. In reality the opposite is true. In terms of average living standards, our economy is going through its biggest crisis of my lifetime. Forget about lost decades: annual pay in real terms is not expected to reach the pre-crisis peak until 2025. Productivity growth has been minimal since the low point of the recession eight years ago, and living standards have been further depressed by two large depreciations in Sterling. We now have an economy where growth is slowing, just when growth is picking up everywhere else.

The relevant question for this budget is what the Chancellor is doing about it. The answer, at least according to the OBR, is almost nothing. We know this because the OBR’s growth forecasts take account of all the Chancellor's measures in this and earlier budgets. So in spite of everything this government has said it has done to boost growth in this budget and beforehand, the OBR expect growth per capita to be less than 1%, compared to a steady average of 2.25% between the 1950s and the financial crisis. [1] All the Chancellor can claim is that growth would be even worse still if he had done nothing, or that the OBR has got it wrong.

In truth, though, he is doing almost nothing to boost growth. Rather than expand demand through fiscal expansion, as would be entirely appropriate given that interest rates are at or very near their lower bound and the Bank has been undertaking QE, he is continuing the erratic fiscal contradiction we have seen since 2010. There is a 1% contraction in the cyclically adjusted primary balance pencilled in over the next five years.

The most obvious tool that the Chancellor has to boost both demand and supply is public investment. With the cost of borrowing so low, almost every economist would argue we really should be seeing significant amounts spent on infrastructure investment financed by borrowing. After large cuts in 2010 and 2011, in the last few years we have seen public investment as a share of GDP increased marginally in each budget. In 2017/18 it is expected to be 2% of GDP, rising to 2.3% in 2022/23. This is similar to levels before the financial crisis, when the economy was in good health and the cost of government borrowing was much higher. In other words this level of public investment is totally inappropriate given the cost of borrowing and the extent of the macroeconomic nightmare we are living through.

But, surely, this is a budget for housing, that will finally help all those frustrated first time buyers get on the property ladder. That is what many of the papers tomorrow will claim. The OBR has estimated how many new first time buyers the cut in stamp duty will create: 3,500. As any economist will tell you, the main effect of this kind of measure is to raise house prices, benefiting existing house owners. So this Chancellor is continuing his predecessor’s habit of throwing public money at house owners to keep prices high. [2]

What about all these new houses? assuming they will be built. These would be welcome, but the impact over the next few years on house prices will be minimal given the size of the existing stock of houses. I would guess that a fiscal expansion that let interest rates rise significantly would do far more to bring house prices down, and much more quickly. (To see why, read this.) But then what Conservative Chancellor wants a large fall in house prices on his watch.

Of course there were some other welcome things in the budget, like more money for the NHS. But it is peanuts, and according to the Medical Director of NHS England it will not prevent already high waiting times rising further. The Chancellor is in effect telling those waiting even longer for operations that he is sorry but it was more important to spend £3 billion preparing for Brexit. 

What the Chancellor did not do is just as important as what he did do. This year's measures and previous plans continue to move money from the poor to the better off: cuts to tax thresholds and a freeze on fuel duty paid for by maintaining the cuts in work allowances for families that are part of Universal Credit, and freezes on other benefits. Another regressive budget from a Conservative Chancellor.

I have not mentioned anything about fiscal targets and fiddles to achieve them because it is these targets that helped get us into this mess and restrain this Chancellor for doing enough to make a difference. With demand, investment, the NHS and elsewhere, we can see how the Treasury view prevents the Chancellor taking action of the magnitude required by the scale of this crisis we face, a crisis made far worse by the stupidity of Brexit. Austerity lost us a decade, and Brexit looks set to make it two, but do not worry: the Chancellor is rearranging the deckchairs.

[1] There must be a strong suspicion that even this depressing OBR forecast may be too optimistic. The projections assume that the recent fall in the savings ratio is largely permanent (Chart 3.23). I would be rather surprised if that turns out to be true.

[2] If this was part of an attempt to replace stamp duty with higher taxes on housing wealth I would welcome it, but it is not.  

Budget Day Nonsense

For the last several budgets/autumn statements I have agreed to write an immediate response for some media outlet, and have therefore felt obliged to watch either the speech itself, or the media reports on the day. The good news is that no one has asked this year, and so I can ignore all budget coverage until tomorrow. This will leave me better off, because in macroeconomic terms most budget day coverage has over the last seven years been largely nonsense.

I can confidently forecast that today you will hear a great deal, at great length, about how the path of government borrowing has changed since the Autumn Statement. Journalists will ask endlessly whether he has done enough to reduce borrowing, or whether he had enough money to spend more. At the moment this is all utterly meaningless. In fact it is worse than that. It encourages people to think that government budgeting is just like household budgeting. It is, to be blunt, what gave us the disaster that was austerity.

What any macroeconomist should ask of this budget is has the Chancellor done enough to get UK interest rates off the zero lower bound: to get us out of what economists call a liquidity trap. When interest rates have gone as low as the Bank of England feels able to take them, then it has lost control of the economy. That is the situation right now. The only duty of the Chancellor in that situation is to give the Bank back control through a fiscal stimulus. [1] If he does do that the short term deficit and borrowing numbers that go with that stimulus are completely irrelevant. If he does not do that his budget has failed.

That is basic macroeconomics. But you will not hear any macroeconomics from the Chancellor, or most of the mainstream media. The idea that the Bank does macroeconomic stabilisation and the Chancellor does bookkeeping has become embedded in mediamacro, and even seven years in a liquidity trap has not been able to change this. Alas even the IFS, which is so brilliant at everything else, does not do macro and so reinforces the household budgeting metaphor.

Mediamacro will also spend hours talking about the OBR forecasts for this year and next. This too is pointless. I am sure the OBR will do what it normally does, which is put together a short term forecast that is not far from the average of other forecasters. To their great credit, they also forecast GDP per capita. It will be interesting to see who in the media picks that up. No doubt Brexiteers will go on about how great the economy has been in 2016 despite all the gloomy forecasts. There is a simple antidote to this, which any journalist can apply. Note that a great deal of the growth in GDP in 2016 was due to immigration, the same immigration that the Prime Minister has said was the cause of the Leave vote. [2]

What the better journalists focus on from the OBR is its forecast of where trend output is and how fast this trend will grow in the future. That is the only thing that will influence how much the Chancellor thinks he can borrow in future years. It is the only forecast that matters for future budgets, and as I have already noted it should have no influence on the current budget. Note particularly how the OBR has had to adjust its forecasts for future growth and tax receipts as a result of Brexit. (On this, see some good analysis by IPPR’s Catherine Colebrook.)

Of course the individual measures the Chancellor announces (either in his speech or elsewhere) are important. But even here a day’s reflection is useful, to deconstruct the spin and put the measures in context. (Once again, the OBR’s document can be very useful in that respect.) For pretty well anything the Chancellor does on the spending side, one important context is the extent to which he is just reversing the cuts his predecessor ordered. This is why the IFS wisely waits a day before presenting its post-budget analysis.

What I hate most about budget days nowadays is the constant repetition by government politicians, echoed by mediamacro, about not being able to afford improvements to public services. The reality, the detail of which Polly Toynbee sets out clearly, is that this government has managed to cut plenty of taxes which seem to have been affordable. But there is a deeper concern.

As I showed in this post, the performance of the economy since 2010 has been terrible. There has been no recovery, using the proper meaning of the word, from the Great Recession. All this time the Bank has been forced to keep interest rates at or near their floor, and use incredibly inefficient instruments like QE, because the government has kept on cutting spending. It is not normal to cut spending in what should be a recovery phase of the business cycle: at least not normal since the mistakes of the 1920s and 1930s.

In the years immediately following 2010 the government could claim its austerity policies were the international consensus, but no longer. In the Eurozone outside Greece austerity has come to an end and their recovery is gathering pace. In the US the central bank, for better or worse, is raising rates. Only in the UK does austerity continue and the economy continues to stagnate. Which is why I’m glad I do not have to watch lots of people completely ignoring all these points today.

[1] I’m not talking measures that might allow the Bank to raise interest rates by a quarter of 1%. I’m suggesting a stimulus such that members of the MPC say unequivocally rates will need to rise, and the only debate is by how much. Anything less than this just allows the economy to get blown back into a liquidity trap when something mildly bad happens.

[2] As background, GDP per capita increased by just over 1% in 2016, which does not sound so good. Average growth from 2010 to 2016 has been 1.2%, compared to 1997-2010 when the average was 1.4%, a period which included a global financial crisis and the worse recession since WWII. Having to get the deficit down is no excuse for this terrible performance, because fiscal consolidation need not reduce GDP if it is done outside a liquidity trap. This is the basic bit of macroeconomics that both this government and mediamacro fail to recognise.   

The Budget and Health Care

The reasons for substantially increasing current spending on the NHS and social care are obvious. Here is some data. The first is from the OECD on UK spending on health over a long period as a share of GDP (source).

This reveals an important truth which talk of ‘protecting the NHS’ is deliberately designed to ignore: health spending increases as a share of total GDP over time. The two noticeable points beyond that are the increase in spending under Labour, and the slight decrease in spending under the Coalition government.

One area of health spending that has been particularly hit in the recent past has been spending on social care by local authorities (source).

It is in areas like this that I get so frustrated with TV journalism. I have seen countless segments or interviews on what is causing the current crisis in the NHS and health care, but I do not remember ever seeing graphs like this. Is there an unwritten understanding in the TV networks that people cannot read graphs?

The outlook for the next five years for total health spending is further falls relative to total GDP (source).

The red bars are the projected growth in GDP, and the blue bars the projected growth in health spending. Unless something is done the current crisis in social care and the NHS will get worse and worse.

This increase in spending should be permanent and financed by a permanent increase in taxes. As such a specific tax funded increase in spending would be popular, it seems sensible to do it that way. Given the current crisis in the NHS, if this is not done in the budget we either have to downgrade our assessment of the morality of our current rulers still further, or assume they really do have an ulterior motive in running the NHS into the ground.

What would be the macroeconomic effect of such a policy change? You might expect a permanent tax financed increase in spending to have no effect. Taxes would rise by an equal amount to the extra government spending, and knowing this was permanent consumers would reduce their spending by the full amount of the tax cut. So private spending falls to offset additional public spending.

There are two reasons for thinking that would not be the full story. First, consumers initially appear not to fully adjust consumption to a tax change, even when that tax change is perceived as permanent. This is quite rational if they hold precautionary savings, and wish these savings to adjust to be a constant share of post-tax income. As a result there might be a short term boost to activity from a tax financed spending increase. This could be amplified, of course, if the tax increase was delayed for a year or two. As interest rates are still at their lower bound, such a boost to activity would be welcome.

Second, spending on health care is likely to be less import intensive than the private consumption spending it replaces. This would give a permanent boost to GDP and permanently reduce the current account deficit. Now both these effects might lead to an offsetting exchange rate appreciation, but the consequent reduction in inflation and boost to real incomes that this appreciation brings would not be unwelcome given the impact of Brexit.

Three final points that I hope are obvious. First these beneficial macro effects are incidental in the sense they are not required to justify the spending increase. The case for additional spending on health care financed by higher taxes is overwhelming on its own terms. Second, this is additional to the large increase in public investment, financed by borrowing, that should be underway right now. The changes in this direction in the Autumn Statement were an order of magnitude too small. Third, the second biggest threat to the NHS right now after lack of money are staff shortages. As an important source of staff is the EU, the government seems to be doing everything it can to make things more difficult.