There are few more depressing events for economists than the annual spectacle of the British Budget. First you have the leaks and rumours. Journalists spoil to identify the potential “rabbit out of the hat” or the exciting policy idea that will “shoot the other party’s fox”. Few seem to believe the Government will seek to improve economic performance or inoculate us against risks to the public finances. Instead, talk of what will be electorally popular dominates.
Then there’s the day itself. The Chancellor’s speech filled with selective data and cringeworthy sound bites. The official documents littered with creative accounting and contradictory measures. New tax complexities and pork-barrel infrastructure announcements lurk throughout. Not to mention the usual ill-thought-through headline measure designed to “win” the press coverage. The Finance Bill is then rammed through Parliament with little debate or scrutiny, throwing up new problems later.
But this year is likely to be even more depressing than usual. The forecasts accompanying the Budget are predicted to show significant downward revisions to productivity growth, meaning much more of the Budget deficit will be regarded as “structural”. Lower growth will be reported as an immutable fact, and the new public finance forecasts as gospel. The Chancellor will likely claim he is subsequently boxed in by the worsened economic outlook, and use it to justify not doing anything radical.
This would be exactly the wrong reaction. First, because the new data itself is inherently uncertain and should not be put on a pedestal. The exact figures matter little. Second, because the Government really should be addressing the underlying challenges by now. To see why we shouldn’t be wedded to exact figures, take the macroeconomy. Back in March 2012, unemployment was forecast by the Office for Budget Responsibility (OBR) to fall to 6.3pc by 2016, accompanied by a robust GDP growth rate rising to 3pc that year. This would be driven in part by a healthy annual 2.2 pc growth rate in productivity (output per hour worked).
What actually happened? The labour market performed even better than expected, with unemployment falling to 4.9 pc. But growth was actually slower than expected. That’s because productivity growth has been persistently weaker than forecast. Output per hour worked actually declined 0.2pc in the year to Q2 2017, for example, compared with forecast growth of 1.6pc. The OBR will now finally adjust its expectations.
This can largely explain why the public finances have been so much weaker than expected. Back in June 2010, the OBR believed the budget deficit would fall to 1.1pc of GDP by 2016, with the structural deficit almost entirely eliminated. Net government debt would peak at just over 70pc of GDP in 2014 and then fall.
Official data instead show the deficit was still 3.8pc in 2016, and almost entirely believed to be structural. Now the OBR says the debt-to-GDP ratio was 83.6pc in 2016 and will not peak until 2018.
Forecasting, of course, is well-acknowledged to be fraught with difficulties. But it’s not just the long-term macro calls where large uncertainties arise. There is considerable doubt often about the state of the economy in real time too, and subsequent revisions to GDP estimates. In November 2011, for example, it was thought that 2011 growth would be recorded at 0.9pc. It has subsequently revised up to 1.5pc. In December 2012 it was believed the economy shrank overall for the year. The eventual recorded out-turn for 2012 was 1.3pc.
Then there’s the uncertainty of how macro trends affect real spending and revenues. In late 2011, it was projected corporation tax receipts would rise to £42.3bn by 2017. In the interim, the tax rate was slashed and GDP growth underperformed expectations. Yet despite this, actual receipts for 2017 are projected to be £52.8bn, 25pc higher than originally envisaged.
The point here is that the political obsession with how forecasts affect the “structural deficit” is misguided. Any calculation to estimate the true “structural” deficit must accurately assess current activity, the true potential of the economy, and how reaching that potential would affect spending and taxes. As we have seen, the OBR has a poor track record in all these areas.
Rather than tying so much weight to this inherently uncertain calculation, and talking about new “black holes” when forecasts change, policy should be guided by fundamentals and what is within the control of politicians. The UK is still running a large budget deficit and debt-to-GDP is high by historic standards. Productivity growth has indeed been pitiful for years. Simply hoping year-on-year for a robust productivity recovery looks like a dud strategy.
Indeed, the biggest criticism of Conservative management of the economy since 2010 is surely that they have not delivered on the supply-side for growth, making lots of noise about infrastructure and apprenticeships when the real low-hanging fruit is planning liberalisation, pro-growth tax reform and opportunities for deregulation emanating from the Brexit process.
All of these are still desperately needed, but it appears unlikely this Government has the political capital to deliver any of them.
Likewise, the past seven years have shown too that the Government can assert a great deal of control over spending levels. But few would now believe the minority Conservative Government could even pass another round of spending cuts through Parliament.
This Budget is likely to be particularly depressing then, because the Conservatives are politically paralysed from doing anything substantial to either boost growth or reduce the deficit. The Budget will be dominated by the doom-and-gloom of highly uncertain forecast changes, with little actual policy change to address Britain’s key challenges.
Ryan Bourne holds the R Evan Scharf Chair for the Public Understanding of Economics at the Cato Institute