Thursday, 21 March 2013

Chancellor banking on a late economic spring

This year I produced my post-Budget response for the IPA, the membership body that aims to raise organisational performance through workforce engagement. I have the IPA's permission to publish this on my own site

George Osborne delivered his fourth Budget statement to Parliament in time for the spring equinox. The economic climate he has to contend with is even chillier than our very un-spring like weather. But rather than spend more directly to warm things up, the Chancellor kept the fiscal thermostat low and turned instead to the Bank of England to apply a bit more heat while offering a little comfort in the form of targeted tax and infrastructure investment measures paid for by a tighter squeeze on public sector budgets. Mr Osborne is clearly hoping that the delayed economic spring will not be too long in coming. But how much longer might he and the rest of us have to wait?

Grim arithmetic

The basic economic arithmetic is fairly grim. According to the latest forecast from the Office for Budget Responsibility (OBR), the economy will grow by 0.6% this year, half what the OBR forecast last December, though fingers crossed we should avoid a triple dip recession. And even though things are gradually expected to improve from 2014 onward, growth will be insufficient to absorb all the spare capacity in the economy for some considerable time to come. Consequently, unemployment isn’t expected to fall below 2.5 million until the second half of 2016 and will still be above 2 million five years from now.

An anaemic economy means weak tax revenues, so the Chancellor is struggling to get to grips with record government borrowing and public debt despite the cuts in public spending he set in motion when taking the helm at HM Treasury in 2010. The OBR reckons public sector net borrowing will be close to £120 billion last year, this year and next year. In 2010 Mr Osborne hoped that by this year net debt - the cumulative sum of government borrowing - would have peaked, albeit at a fairly horrendous 70.3% of GDP. In fact, the peak is now expected in 2016-17 at an even more horrendous 85.6% of GDP.

Persisting with Plan A

Critics argue that slow growth, stalled progress in reducing government borrowing and a rising debt burden prove that the Chancellor’s so-called ‘fiscal plan A’ has failed. Mr Osborne counters, extending the meteorological metaphor, by arguing that he is travelling the correct path but has encountered more difficult weather than expected, notably a cold blast from across the Channel where the Eurozone is doing even worse than the UK, which seriously dents exports. Either way, the Budget shows that he has no intention of changing course, which means that it’s essentially Plan A from now until the General Election due in 2015.

This doesn’t mean the Chancellor is doing nothing, merely that he isn’t heeding the calls of his opponents who would countenance an increase public borrowing in the short-run in the belief that this would stimulate stronger economic growth and help cut borrowing even more in the medium term.

Bank to the rescue?

Although the Budget is broadly fiscally neutrally for the period 2013-14 to 2017-18, it contains various supply side measures designed to foster an ‘aspiration nation’, including cuts in business taxes and a £5 billion injection of off-public balance sheet finance aimed at the housing market, while also changing the remit of the Bank of England’s interest rate setting monetary policy committee (MPC), enabling the MPC to use ‘unconventional policy instruments to support the economy.’ The remit change is written on the welcome mat at Threadneedle Street ahead of the arrival this summer of new Governor Mark Carney.

The main question mark over this policy of fiscal constraint, monetary activism, and supply side reform is that it’s been the bedrock of Mr Osborne’s economics for three years and for three years failed to deliver the goods. The economy has flat-lined. Unconventional monetary policy instruments have had the drawback of pushing up inflation. And several supply side Plans for Growth aren’t obviously working as far as one can tell.

Job market success

However, the Chancellor can point to one particular recent success story, the performance of the UK labour market. A stagnant economy in which, as the OBR highlights, the public sector will have shed 1 million jobs between 2010 and 2018 is creating jobs at a rate normally seen only during periods of boom.

Adjusting for statistical distortion there are 1.04 million more people working in the private sector since Mr Osborne’s fiscal austerity began – with 6 new private sector jobs for every lost public sector job in 2012 alone. This is obviously little comfort for public sector workers in fear for their jobs and who, as Mr Osborne announced in his Budget, not only face an extension of the 1% cap on pay rises but also, and perhaps more significantly, curbs on progression pay increments. Moreover, the downside of rising employment in a stagnant economy is falling productivity and cuts in real pay for private sector workers too. But from both a social and economic point of view strong employment growth is preferable to the even higher unemployment that would otherwise have accompanied austerity.

Indeed the OBR, which is gloomy about the outlook for most key economic indicators, is more optimistic about prospects for the labour market than it was in December. The number of people in work is expected to rise by around 100,000 more than previously forecast this year, though the increase in average earnings will at just 1.4% remain well short of consumer price inflation of 2.8%.Unemployment is expected to peak at a somewhat lower rate (8% rather than 8.2%), elevated slightly above the current rate of 7.8% only because of strong growth in the number of people active in the labour market. Overall, private sector employment is forecast to be 2.4 million higher in 2017-18 than in 2010-11, with total employment, accounting for public sector job cuts, 1.4 million higher.

Employment Allowance: a good idea?

Not content with this, the Chancellor wants even more job creation. One of the centrepiece measures of the Budget was therefore a £1.25 billion Employment Allowance offered to employers. The Allowance, which when introduced in April 2014 will cut the employers’ national insurance (NICs) bill by £2000 for around 1.25 million, mostly small businesses and charities, is a potentially positive move. The Labour Party as well as business organisations have welcomed it, providing a rare example of something both Mr Osborne and his Labour shadow Ed Balls agree on. Yet popularity aside, the consequences of the Allowance for jobs and the wider economy is uncertain.

The impact of the Employment Allowance on jobs will clearly depend on take up – itself dependent on demand for the goods and services of business and charities as well as their access to finance– and could be prone to an element of deadweight by offsetting NICs for employers that would have hired the same number of people anyway. Similarly, the cut in NICs might be absorbed into higher profits or passed on in higher pay to employees, without boosting hiring. Not surprisingly therefore, the OBR thinks it will have only a marginal impact on labour demand.

The overall cost effectiveness of the Employment Allowance might also be questioned. At a time of falling real wages and very strong employment growth it’s not obvious that the cost of labour is a significant constraint on job creation, even for small businesses. In this context, a further reduction in labour costs could act as a disincentive to capital investment and deter much needed improvements in labour productivity. If so the Allowance might not be as beneficial a policy measure as it appears. In the absence of a full Treasury impact assessment the jury should remain out on the measure.

We needed a Budget for Investment

Overall, however, any concern about the effect of the Employment Allowance on investment pales into insignificance alongside the overall weakness of UK business investment at present. Although the OBR sees this as an important driver of growth, its forecast for business investment between now and 2017 is considerably weaker than that published last December . This is perhaps the most worrying aspect of the OBR forecast, which attempts to take account of the impact of the Chancellor's Budget measures. Without much faster business investment the economy won’t achieve the truly desired combination of higher productivity, higher employment and higher real pay. Neither will the economy rebalance away from over-reliance on consumer spending as a driver of growth.

Budget 2013 needed above all to be a Budget for Investment. This would actually have had a more important impact on aggregate demand and jobs than any measure targeted specifically at boosting employment, as well as underpinning future economic prosperity On that measure, if the OBR forecast proves correct, the Budget looks to have fallen short.     

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