As my posts are
usually written just before Budgets happen, I will add a postscript after the Budget
To say that much of
the media treats Budgets as if the government was a household is not
really accurate. Much Budget analysis treats the government as a cash
constrained household, such that any change in expected tax revenue
is regarded as money the Chancellor has to spend or give away. Most
households don’t work like that, because they have the capacity to
save and borrow. The government of course finds it much easier to
borrow than households.
Unfortunately some
governments encourage the media’s attitude to Budgets. On this
occasion, however, the government’s fiscal rules are medium term,
with targets always five years into the future. So there is nothing
in these fiscal rules to suggest that temporary improvements to the
government’s fiscal position need to be spent or given away. The
reason they are likely to be spent or given away in the forthcoming
budget is because we are close to an election. But because many in
the media treat the government like a cash constrained household,
what in reality is fiscal electioneering will be portrayed as normal
practice.
The forthcoming
election is likely to influence Chancellor Hunt’s first Budget in
two ways. First, he will want to produce fiscal giveaways that will
make newspaper front page headlines the next day, and perhaps sway
some voters to vote Conservative. Second, he will want to try and get
the economy growing again as quickly as possible. The reason why can
be seen from this chart.
Whereas the US
economy at the end of last year had GDP per head around 4% above its
level at the end of 2019, the UK economy had GDP per head around 2%
lower. This number may be flattering to the US because at the end of
last year at least it was probably running a little hot, but the same
is true of the UK yet GDP per head is still significantly lower than
before the pandemic. The UK’s relative performance over the last
three years has been even worse than its
performance in the decade since 2010. The Chancellor
will be desperate to see some positive economic news before the
election, and hope that enough voters are myopic enough to forget how
bad things have been since 2010.
One of the reasons
why the US has performed so much better than the UK since 2019 is
that Biden had a clear long term plan of how he was going to support growth,
while the UK did not. That plan involved first ensuring a strong
vaccine enabled recovery from the pandemic using a fiscal stimulus
focused on poorer citizens. Then came large instructure projects,
followed last year with incentives for greening the economy. In
contrast the strategy of the Conservative government since 2010 has
involved shrinking government, tax cuts for firms and Brexit. The aim
was to let an ‘unburdened’ private sector do all the work, and it
has been a complete failure.
A conventional
pre-election fiscal stimulus runs the risk of encouraging the Bank of
England to raise interest rates yet further. That suggests he will
look at measures that increase aggregate supply as well as aggregate
demand, and so might be regarded by the Bank as inflation neutral.
Trying to increase aggregate supply is laudable of course, but
unfortunately he is likely to shun the two most obvious choices: more
public investment and better health.
In his Autumn
Statement he had already cut back on public investment, and it will
be interesting if he goes further. Delaying the
completion of HS2 is an example of what John Elledge
had earlier
called ‘Treasury brain’. Such delays in
investment rarely
save money in the longer term, and obviously they
delay getting the benefit of the investment. It’s not as if the UK is
‘world beating’ with high speed rail – it’s actually way
behind much of Europe. What is important here is not
the rhetoric, which is always positive in Budget
speeches, but the actual numbers for aggregate public investment,
which I will report on in the postscript after the Budget. With so
many good reasons to increase public investment in so many areas, it
is so short sighted to be cutting it back. If public net investment
over the next few years remains below 3% of GDP this will be a
consequence of the stupidity
of including public investment in the fiscal rule targets.
The Chancellor will
probably do something to tackle the large number of inactive people
of working age that is one of the two key factors behind the UK’s
current labour shortage (the other is Brexit). However, as this
report argues, the main reason why this problem has
been so uniquely persistent in the UK since the pandemic is the large
number of people not working because they are sick, which in turn
reflects the chronic state of the NHS after thirteen years of
Conservative government.. Providing more money to the NHS (the report
dubs this “check-ups to pay cheques”) is the best way to achieve
this. Yet other reports
suggest that the Treasury is trying to stop plans for more NHS nurses
and doctors, which in turn suggests the Chancellor is unlikely to
provide assistance where it can be most effective.
One area where he
may well act to increase demand and supply is incentives for
investment by firms. While these incentives generally sound like a
good idea, there is a danger that all they do is bring forward
investment to years where the incentive applies from years when it
doesn’t. If that is all that happens then little has been achieved
from a long term point of view, yet with the cost of government
payouts to the firms doing the intertemporal switching. However if
the Chancellor wants to boost investment in an election year, at the
expense of lower investment under what may well be a Labour
government, this may not be his major concern!
Low public
investment, ignoring the long term sick, and politically motivated
subsidies to firms are all examples of where poor political decisions
mean that fiscal policy fails to improve the economy in the longer
term. If the headline grabbing giveaways include not
raising petrol duty yet again, then we can add that to
the list. The media will report this as ‘popular with motorists’,
as if motorists are united in welcoming climate change.
As I noted in this
post, the United States has for the first time a clear
plan to encourage the kind of green industries which will play such
an important part in all major economies over the next few decades.
As their plan is also protectionist, it has encouraged the EU to
increase
subsidies for these industries. The UK needs its own
response. As Torsten Bell points
out, it cannot just be an attempt to duplicate what
the US and EU are doing, because the UK is a smaller, more open
economy that needs to play to its strengths. It will be interesting
if we get any idea from the Budget about whether the current
government has started to think about what the UK’s strategy on
encouraging green industries should be, or whether it is continuing
with the failed plan of hoping general corporate tax breaks will
invigorate the economy.
