Vista - The outlook

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18/12/2019
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I’m writing this in the middle of the UK general election campaign, so you will be reading this when it is (thankfully) all over! So, I’m not inclined to make any predictions about the outcome of what everybody (bar the betting websites) is saying will be an exceptionally difficult election to call – the chances of looking foolish are just too high.

But it has been interesting, to say the least, to observe the deterioration in the quality of political debate around the election. To characterise the nature of the “discussion” around Brexit as a debate, however, would be flattering indeed. The parties have generally stuck to their pre-ordained positions, perhaps recognising that the public by now is bored to death of the subject and just wants closure. To argue, as the Prime Minister has done, that a Conservative majority will “get Brexit done” is just plain nonsense. I’ve argued on these pages many times and will reiterate now that passing the Withdrawal Agreement merely fires the starting gun on the next and probably prolonged phase of negotiation between the EU and ourselves on all aspects of our future relationship.

A major shift in fiscal policy

Elsewhere, the parties appear to be competing with each other to offer bribes to an electorate increasingly disillusioned with the political class. The extent to which these bribes are actually deliverable is another matter of course. But whichever of the parties wins the day, it seems as if we are on the cusp of a major shift in fiscal policy.

I always find the Institute of Fiscal Studies (IFS) website a mine of useful information and make no apologies, in this turbulent time, for referring extensively to its work in this post. While the IFS has yet to publish its full analysis of the various parties’ spending plans, and it cannot until the manifestos are published, it is already drawing some interesting conclusions.

Remember that throughout the last 10 years, governments have been battling to remediate the impact of the Financial Crisis of 2008/9. The impact of that catastrophe was to raise the UK’s annual budget deficit, basically the amount the Government has to borrow to fill the gap between income and spending, and also to raise the stock of net debt, the sum total of outstanding borrowing. To put this in some perspective, the deficit rose from £46bn in 2007/8 to £158bn in 2009/10, or from 2.9% to 10.2% of national income. (Source: Institute of Fiscal Studies)

The need to get borrowing down

The government mantra of the subsequent years was the need to get the level of borrowing down again – the Conservatives called this fiscal prudence, the opposition austerity. The deficit was gradually reduced, largely by means of spending reductions since there wasn’t a huge amount of growth in the economy to raise incomes. 

Back at the start of this year, there were signs that the policy was well on the way to meeting its targets - though to be fair, those targets had been repeatedly modified over the years. Last year’s deficit was £41bn, or 1.9% of income and this year’s is expected to come in under £30bn. (Source: Institute of Fiscal Studies)

Spending increases

However, it had been the Government’s overarching fiscal objective to get the annual deficit down to zero by the mid-2020s. The reason for this being that the big increases in borrowing in the last decade pushed up the stock of debt to almost unprecedented levels. Whereas public sector net debt was running pre-crisis below 40% of national income, it is now at c75% and has not fallen much in recent years. 

There were signs even before the election that things were changing. The September spending round announced by the new Chancellor, Sajid Javid, incorporated substantial (£13bn) increases to the budgets of the spending departments with no attempt to finance these from higher taxes, implying deficits for the next couple of years in excess of £50bn.

That does not consider the additional spending increases promised by the Conservatives nor the eye-wateringly large commitments on investment and infrastructure (e.g. the £250bn Green Transformation Fund) promised by Labour. 

So, what are the implications of all this? Is it a good thing that austerity really does seem to be at an end?

In some respects, yes. I have written before about the unsustainable nature of economic policy around the world – the fact that all governments seemed to be intent on deficit reduction, meaning all the strain of economic stimulus fell upon monetary policy, or interest rates. Unconventional monetary policy in these circumstances had driven bond yields down to extraordinarily low levels and this was itself threatening the stability of the financial system.

So, the fact that both major parties in the UK seem to be switching on the fiscal taps can be seen as a good thing. Borrowing will go up, growth should benefit, bond yields should rise back to more “normal” levels. However, as the IFS puts it, “if you are going to borrow a lot more for investment then you need to make sure that it is good investment”. Debt incurred simply to pay for current spending is not going to offer the rate of return for future generations to cover the additional interest burden on those generations.

Long term trends

Furthermore, there are some long-term trends in our economy which imply a potentially significantly increased burden on government spending in future years in any case.

  • Ageing population; as the demographic profile of the UK ages, along with many other countries, the amount of money required to be spent on pensions and healthcare increases. The Office for Budget Responsibility has estimated that spending on these items will have to increase by 1.7% of national income over the next 10 years. 
  • Climate change; the ongoing impact of climate change is already in evidence this winter. But meeting the commitment for the UK to get to net zero greenhouse gas emissions by 2050 will require huge investment
  • Low productivity and in-work poverty; the productivity performance of the UK workforce (changes in the amount of output per hour worked) has been unprecedentedly poor since the financial crisis. In fact, output per person per hour hasn’t changed much over that period. Since living standards rise with productivity, the earnings of many workers have not kept pace with inflation, so that most people living below the poverty line in the UK now are actually in working households.

Compared to these challenges, the issues raised by Brexit could be considered a sideshow. One can but hope that whichever party wins out in the election, these crucial long-term issues are given the consideration they deserve.

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