How well has the Chancellor’s economic policy performed against its own targets?
05 December 2012
Today’s OBR forecasts suggest that it now considers that a larger proportion of the deficit was driven by the economic cycle instead of being a permanent structural hole in the public finances. This turns out quite favourably for the Chancellor; the government’s fiscal target is to eliminate the structural deficit by 2016/17, and although the Chancellor has admitted to missing his fiscal target, he will not be missing it by quite as much with this revision.
The key judgement the OBR makes to determine how much of the deficit is cyclical and how much of it is structural is the output gap. Theoretically, the output gap measures the underlying capacity for the economy to grow without giving rise to inflation, debt imbalances or other factors that could cause a subsequent correction in the future. The size of the output gap also has important implications for the long-term growth rate for the economy – if the amount of spare capacity in the economy is very limited, then the growth prospects in the medium term will be limited as well.
In today’s forecasts the OBR has revised its view on the size of the output gap. They now assert that the output gap is larger in 2012 than they had previously forecast. Ironically, this is not based on its model, but on the rather arbitrary assumption that total factor productivity (the increase total output not caused by labour and capital, often summarised as increased productivity from technological progress) is flat, rather than negative as their model implied.
At the heart of all of the Chancellor’s plans is the so-called Plan A – the fiscal consolidation. He has now missed his fiscal target to eliminate the structural deficit by the end of parliament, despite an arbitrary and helpful revision by the OBR. It would be interesting to see how much he would have missed this target by without this revision. It is difficult to reach any conclusion other than that the Chancellor’s plans have failed, even in their own terms.
The government’s chief defence cites external factors such as the Eurozone and the stalling Chinese economy, yet there is mounting evidence that many UK businesses are finding it harder to raise capital for growth. There are many domestic constraints to growth, such as access to finance, which the Chancellor could have addressed in today’s statement. Instead, his key policy lever was to tweak the composition of his deficit reduction plan.
The Autumn Statement had little in the way of policy and details of the government’s plans to unlock growth. There were a series of spurious spending and tax announcements to maintain the fiscal neutrality of the statement. It is essential for the Chancellor to now shift focus from fiscal consolidation to putting medium to long-term growth at the heart of all of his plans. Holding all other policies hostage to deficit reduction plans are harming prospects for long-term growth and thus making the Chancellor’s fiscal targets even more elusive.