Budgets – and this Autumn Statement is in effect half of the Budget next spring – are about three things: the economy, finance and politics. On the first two, Jeremy Hunt had reasonably good news. On the third – well, we will see.
The economy first. It has been growing somewhat faster than the Office for Budget Responsibility (OBR) expected last March. But inflation has been higher too. That brings in higher revenues but also increases welfare benefits, and rising interest rates increase the cost of servicing the national debt. But by holding down other government spending there has been what the OBR describes as “a fiscal windfall” of £27bn, and it was that which enabled the Chancellor to cut National Insurance, increase allowances for investment, and still have debt falling over the next five years.
Is this faster than expected growth real, and if so, will the raft of measures announced really increase it? The Chancellor has leant heavily on the OBR to justify his claims, doing exactly the opposite of the Truss government last autumn, which excluded it from the whole process.
The OBR, for its part, has had to acknowledge that it has been over-pessimistic about both the economy and public finances. It is now expecting somewhat higher growth than the Bank of England is, though it is pretty much in line with private sector forecasts. Back in the spring, it thought the economy would shrink. Now it estimates growth this year will be 0.6 per cent. That is a big turnabout, and comes on top of the Office for National Statistics discovering that the economy is around 2 per cent larger than it thought.
But 0.6 per cent by any historical standards is dreadful. Forecasts for the next five years are dismal too. While we should not take any projection four of five years in the future too seriously, the harsh truth is that annual growth of around 1.5 per cent would be well below the very long-term trend for the UK, which is about 2.25 per cent. It is all very well Mr Hunt saying that our growth record has been better than much of continental Europe – and you can play around with the statistics to show that is true – but it has been a sight worse than the United States, and somewhat lower than other Anglophone economies such as Canada and Australia. We are not doing very well.
There are two broad explanations for that. One is that the UK has underinvested – and that is the point made by Mr Hunt – and that is broadly right. The other is that it is much harder to improve the productivity of service industries than it is of manufacturing. This applies to all developed economies, including the US, but particularly to the UK as it is largely a service economy. As the Chancellor said, the UK is the eighth largest manufacturer in the world – but only the eighth. What he didn’t say is that we are the second largest services exporter in the world, after the US. The challenge will be to lift the whole economy, manufacturing services, the public sector, the lot.
That leads to the biggest economic question raised by the Autumn Statement: will the measures the Chancellor announced really bring any long-term boost to growth, and hence to prosperity?
That is a tough one. We know that UK companies don’t invest enough. We know we don’t build enough homes for our rising population. We know, or at least can be pretty sure, that some people are discouraged from taking on jobs because of the tax burden on paid work. So there was that string of 110 measures, plus the cuts in national insurance, designed to change all this. It would be nice to believe that there will indeed be a radical shift in performance, and it is worth making the point that the measures won’t do active harm. But the problem with all economies is that the finance minister of the day may pull levers to try to change things, but he or she will not know whether there is anything attached at the other end. Economies don’t grow faster because some politician tells them to.
What a finance minister does have to do is try to balance the books. There is a practical limit to the amount any government can borrow, but there is also the question of how that borrowing is used. If the money is going into genuine investment that is one thing. If it is simply supporting current spending then it becomes a problem. Since the borrowing numbers, even with the big cut in national insurance, have been approved by the OBR, it looks as though the financial markets are onside.
No one believes the projections three years in the future. But the markets do want to see a credible path that borrowing will head down in the long term, certainly to below 3 per cent of GDP, the Maastricht target for European Union countries and the de facto limit for an economy such as ours. The first reaction on the gilt market was reasonably positive, with the 10-year yield steady at 4.1 per cent. So the Chancellor’s key financial test – are the projections credible? – has been passed.
And the politics? Well, it will be for voters to decide, and they have a few months to ponder about that. What I think this Autumn Statement shows beyond any reasonable doubt is that we are at the acceptable limit of taxation. Since the Second World War, every time a government seeks to push the percentage of GDP taken in tax towards 40 per cent it gets driven back. So any future government will have to find ways of achieving its social and economic objectives in some other way. That will be the harsh reality facing the UK’s next government, whoever gets to form it.
It is always hard, when faced with a great wodge of information, to work out what really matters and what is detail. As far as the big numbers of the Autumn Statement are concerned, what is interesting is how little has changed. As the OBR has pointed out, Mr Hunt has used up most of the headroom since last March by the cut in national insurance.
What has changed is the economic outlook, not his overall fiscal stance. Fiscal policy is still being tightened, so the outlook for monetary policy remains the same. My judgement remains that the first cut in the Bank of England’s base rate will probably come in May. However, I can’t see the plethora of measures that supposedly will boost growth actually doing any damage, and that does adhere to the spirit of the Hippocratic Oath, in simplified form “first, do no harm”.
The truth is that we won’t know for at least a couple of years whether these measures will move the dial, though the investment incentives do seem to have the support of large companies and that is certainly helpful.
The other striking thing about Mr Hunt’s plan was what was not there. Nothing on inheritance tax. Nothing on income tax… and yes, I know national insurance is a sort of income tax. Nothing on VAT, including a potential increase in the threshold, something that the small business lobby has pressed for. Nothing significant on other personal tax issues, aside from the pensions consolidation stuff.
So I wonder whether all this is priming the pump for something significant in the Budget in March, if the numbers continue to improve. If they don’t, well, it will be a rob-Peter-to-pay-Paul operation, which will hardly go down well in the shires.
And will those numbers indeed improve? The positive view, now pretty established in the US, is that there will be no recession on the other side of the Atlantic. That is relevant because for reasons that I have never fully understood, in terms of the cycle rather than overall growth, we seem to track the US economy more closely than we do continental Europe. The negative view is that inflation will prove more sticky than the OBR and the Bank of England expect. That will make it harder to cut rates come May (or whenever), and tighter money will be an increasing drag on the economy through next year.
The bottom line is that the improved outlook has enabled the Chancellor to paint a significantly brighter picture than he could last year. But he needs the clouds to continue to lift for the prospects for further tax cuts to become credible come next March.
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