UK chancellor can use leeway to boost infrastructure
by Meghnad Desai
Wed 30 Mar 2016
George Osborne, the UK chancellor of the exchequer, has been lucky for longer than most politicians manage. He got the kudos for getting the deficit down during the Conservative-led coalition government in the five years to 2015, even though the scale of the reduction was less than promised.
While he was doing that, his critics kept on predicting, if not finding, a double- or even triple-dip recession. With hindsight and income data revisions by the office of national statistics, we find that there was positive income growth throughout the five years. Unemployment was low, though wages failed to turn up.
With the Conservatives now in power on their own after last year's election, Osborne's fortunes are changing. Perhaps the party never thought it would win on its own. Hence it made fiscal commitments which it thought the Liberal Democrats, its former coalition partner, would reject. Alas, victory is a lonely enterprise. So the shortcomings in the arithmetic behind Osborne's 16 March budget have now become evident to all.
Of Osborne's three fiscal promises – lower year-on-year deficits, a lower debt to income ratio and a budget surplus by 2020-21 – only the distant one remains unbroken. He has suffered a defeat on tax credits (though more due to incompetence in parliamentary management than anything else). He has had to weather the resignation of Iain Duncan Smith as social security minister and the withdrawal of planned cuts in disability benefits. A hole of £4.4bn is not much in a budget of £772bn, but the reversal of a budget proposal even before parliament voted on it was a significant setback.
Osborne's Keynesian critics are urging him to borrow while interest rates are ultra-low. The earlier argument favoured this course of action to boost consumer spending, even though the consumption multiplier is not as high as people think. Osborne did not oblige – but ex-post GDP data for 2010-15 indicate that the economy grew by around 2% anyway.
Now the plea is for infrastructure spending. Here the prize is not short-term consumption but the longer-run impact on growth. Osborne can point to many project announcements. But as Lord (Alistair) Darling, a former chancellor of the exchequer, said during a pre-Easter House of Lords budget debate, many of these schemes have been proposed in previous budgets and few lead to any actual spending.
If Osborne wants to restrain national debt, he could turn to the 'miracle trick' of public-private partnerships used by Gordon Brown when he was chancellor, which led to the building of 80 hospitals. The true costs are discovered only in 20 years. In the meantime, the hospitals are there.
Osborne could inveigle sovereign funds or pension funds to finance thousands of socially affordable homes, which would then be leased back to government. The risk would be smaller than with hospitals. The bulk of the revenue would come from the buyers – and the debt would be kept off the government's books.
Regarding Osborne's overall commitment to fiscal discipline, there must be room for adjustment. Given world economic uncertainty, the drastic past data revisions, and the difficulty of forecasting, there is no gain in making categorical commitments. A sensible rule would be to keep the deficit as a proportion of GDP below the growth rate of GDP – let's say 2%, thus preventing the debt to GDP ratio from rising and easing the political tension of budget cuts. This was generally how fiscal policy worked during the good old days of the 1945-75 Keynesian 'golden age'.
GDP growth varies, so contingency plans are always necessary. If he wishes to safeguard his political future, Osborne should prepare for budgets with a considerable amount of leeway. Pedants may decry 'fuzzy budgeting' – but that is what we need in the future.
Prof. Lord (Meghnad) Desai is Emeritus Professor at the London School of Economics and Political Science and Chairman of the OMFIF Advisory Board.
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