A hollow budget

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A hollow budget

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George Osborne is struggling to understand his own economic philosophy and political strategy

Today’s budget is the budget of a chancellor struggling to understand his own economic philosophy and political strategy. Of course, the circumstances are not easy. His inheritance was very tricky and the eurozone crisis has made things worse. Furthermore, David Cameron’s decision to box the government in with a series of ring-fenced spending commitments means that radical reform in many areas is out of the question.

We still await, with baited breath, a reduction in overall government spending. Next year, spending will rise by 2.4 per cent; this year it will rise by 2 per cent. Of course, the brakes have been slammed on in many areas and the total represents a small reduction in real terms. However, households with adults in work are having to reduce their spending faster than the government. Benefit cuts have, in effect, been restricted to working age families.

The huge rise in welfare spending in the first decade of the 21st century has not been reversed and will not be reversed without radical reform of the system. Welfare spending, excluding pensions, rose by 50 per cent from 2000 to 2010 with much of that rise coming while the economy was booming. This is an area that is ripe for serious reform given that over two-thirds of families with children receive means-tested benefits and the vast majority of families with children face effective marginal tax and benefit withdrawal rates of 70 per cent or more. In the absence of reform in these areas, there is no option for the chancellor other than to simply squeeze more tax out of the system and rely on growth and much larger cuts in other areas of government spending to balance the books. And this is the story behind today’s rather hollow budget: “chancellor in self-imposed straitjacket has no room for manoeuvre.”

But, as ever on these occasions, the chancellor has to think of something to say. Deciding not to give a budget speech would not go down well and, given that a budget is to be presented, every effort is made to ensure that there are positive headlines. So, amongst the good news of a reduction in corporation tax (and the welcome simplicity this creates as a result of aligning corporation tax and income tax rates), we have the extension of tax relief for childcare and special tax incentives for private investment in social enterprises, the ceramics industry, high-end entertainment and low-emissions vehicles. All these will have the effect of adding yet more pages to our tax code – already the longest in the world – and creating opportunities for aggressive avoidance.

In addition to this we have a bizarre mortgage guarantee scheme. Perhaps we should just remind ourselves of the causes of the financial crash. Banks in the UK and the US lent money that could not be repaid—in general on mortgages. It is widely believed that this was exacerbated by the belief that banks were underpinned by the taxpayer. In the US, of course, that belief was soundly based given that Fannie Mae and Freddie Mac guaranteed mortgage securitisations. The government has gone to great efforts to reduce bank lending through the use of high capital requirements and to try to ensure that we have legal mechanisms so that banks can fail without taxpayer support. And what happens next? The government introduces a scheme directly providing £12bn of guarantees to house buyers. Guaranteeing mortgages through the back door is out, so we will guarantee them through the front door instead.

This illustrates the core of the government’s problem. There is no strategy or philosophy, simply a series of measures with no common direction.

  1. March 21, 2013

    Tom B

    I can agree with you that Osborne lacks a strategy.

    The mortgage guarantee scheme is absurd. We need more houses built, not further pressure boosting demand rather than doing anything helpful on the supply side.

    Do you have a source for that welfare increase of 50%? How much of that is due to demographic pressures resulting from an ageing population?

    Also, I replied at length to your previous blog again, in case you missed it:

    http://www.prospectmagazine.co.uk/blog/george-osborne-budget-2013-cuts-capital-gains/

  2. March 22, 2013

    philip

    Tom B – thank you for your reply to the previous blog. I read it and appreciate it. Unfortunately, I got diverted on to other things and did not get time to reply again. On that issue, I would just say that the rise (as a proportion of national income) before 2007 was pretty big given the rate at which the economy was growing and so one would expect many elements to be falling as a % of gdp rather than the total going up considerably faster than gdp. And, if you do raise spending rapidly in a boom you have to be prepared to cut it when national income falls (the alternative is to moderate both increases and decreases in boom and bust). The 50% figure I got from the Tullett Prebon report by Terry Smith. He breaks down government spending differently (and more helpfully) than government figures. Some may be ageing population though it excludes pensions. There was a deliberate policy of raising means-tested benefits to families with children and pensioners. It is arguable whether it was a good thing, but it was certainly happening. Some also arises because of direct pressures on the cost of living (housing benefit, for example) which, I believe, should be alleviated by changes to planning policies.

  3. March 22, 2013

    Tom B

    Thanks for the reply. After you questioned whether people were interested in a serious debate, it seemed a rather longer reply was necessary.

    Thank you for the Tullett Prebon report reference. I will look at it in due course.

    Mixing selling off council housing without replacing the stock whilst retaining restrictive planning policies was stupid. I favour both expanded state building and reducing planning policy restrictions, though I assume you only want the latter? Whether any real planning policy changes come through will be interesting – a clear area where the limits of the Tory party’s adherence to free markets is apparent (immigration being another).

    Are there not also good reasons why the GDP spending would expand for certain public sector activities? – not necessarily because they are in the public sector, but because sectors such as health and education are difficult to get productivity gains. Of course, there are many things that can be improved but an academic marking 15 essays or a doctor’s ward round should / will likely take the same length of time now as it will have 30/60 years ago.

    I still don’t think you have addressed my point about private debt vs public debt, thinktanks, the record of Keen and Godley vs most other commentators + politicians. Please do reply on those points if you can find the time.

  4. March 23, 2013

    philip

    thank you…

    yes, as you would expect I would favour planning liberalisation but I really see the purpose of selling off council houses as being to reduce the size of the public sector in this area (by the way, Conservative councils in the 80s were also quite keen to spend the receipts on more council houses). Of course, I agree on the problems the Tories have re both immigration and planning (especially planning – there is probably not much between the parties on immigration). In many respects the planning policy leads to perverse results from an environmental perspective too (longer journeys to work, smaller gardens). My views is that only some kind of compensation principle can over-ride this problem (or at least fiscal decentralisation).

    You might not expect spending to drop as fast as national income in general, but then – ignoring views about the size of the state and just thinking about the cyclical aspect – I think one has to be stricter about rises in spending when the economy is booming if one takes that view. Neither the Conservatives in the late 1980s nor the Labour Party in the early twenty-first century were. One cannot have it both ways. As it happens (a somewhat separate point) I think the potential for productivity gains in education is huge and we will see them in higher education soon – possibly they will come in health too (perhaps in the way treatment is possible in people’s own homes).

    Think tanks are funded differently. I think I am right in saying that the IPPR receives more money from the EU than the IEA receives in total. I do not know the nature, number and size of the IEA’s donors that well (except where the funding is from other charitable sources) because we are very careful to keep editorial and fundraising separate as well as having all publications academically peer reviewed. Our corporate donations are pretty small these days I understand (a big change from 20 years ago). I think that arguments have to be seen on their merit. I have to say that I am never influenced by the views of funders (even when I know who they are – which in general I don’t). I have spoken quite a bit about tax avoidance recently my understanding is (though I never know for certain) that we receive no money from the big names in the headlines on that issue.

    We do not do forecasting at the IEA and most of us there are very sceptical of forecasting – preferring what Hayek called “pattern predictions”. I would argue that Godley got certain big issues very wrong (eg 1981 budget). The correspondents to the FT did not predict a crash as such but an asset price bubble. We published Tim Congdon’s Money and Asset Prices in Boom and Bust in 2006 I think and the title speaks for itself (not that I am with Tim Congdon all the way).

    I do not tend to comment on private sector indebtedness because I believe that private sector agents can take responsibility for themselves unless that indebtedness is fuelled by monetary excess (which I believe it was, at least to some extent). Surely that 450% figure is gross though. It is a concern but less a policy issue than the involuntary inter-generational transfers that arise from government debt. In my view (and we will probably have a panel discussion about this at the IEA in the spring) the left should generally take a very anti-public-debt position (or at least when thinking about net debt after allowing for investment – I guess that Gordon Brown did for a while, but I am not sure to what extent that was conviction).

    thanks for your thoughtful comments

  5. March 24, 2013

    Tom B

    The restrictive policies on immigration for higher education seem to be increasingly accepted by both parties, a depressing point of convergence when allowing more overseas students in could be such a beneficial policy for all concerned for such low cost.

    On the productivity issue for higher education, do you mean it will increase as a result of online learning, MOOCs etc? I think these have been overblown – I still don’t see that the dominance of a 3 year course at a major university will be challenged online. I think they have great potential to add to a traditional university or for those unable to attend university in their own parts of the world. Video recordings of lectures etc can be deployed more, I’m sure, but so much of the most important contact is surely the smaller group work, be it labs for sciences or tutorials in many other subjects. Only time will tell I suppose.

    I don’t know about the IPPR’s funding beyond what they state on their website. Their website says they receive over £100,000 from the EU, but I cannot see further details. They also receive money from Pearson and, would you know it, recently ran what seemed to essentially be an advertorial (they call it a provocation essay) for many of the services Pearson want to sell in higher education:

    http://www.ippr.org/publication/55/10432/an-avalanche-is-coming-higher-education-and-the-revolution-ahead

    It has been rather well taken apart here:

    http://www.wonkhe.com/2013/03/12/were-under-fifteen-feet-of-pure-white-snow/

    Interesting to know that the IEA used to receive a lot of donations from corporates. From any particular sector or can’t you say? Transparency is something that all think tanks should aspire for in my view – otherwise I simply can’t just look at the arguments on their merit. The way in which think tanks project ideas and arguments into the public view is quite disconnected from merit. As thinktanks have an influence I think it is appropriate to know who is supporting them.

    Godley did get the 1981 budget wrong, but he got the crash right in a way in which most did not.

    Surely the changes in private sector indebtedness are a consequence of changed policy though? The graph on page 7 here
    http://cdn.hm-treasury.gov.uk/junebudget_complete.pdf
    illustrates how the increase was a largely constant and consistent trend from the Thatcher Governments onwards. Expanding private debt has supported demand for decades. Loose credit offered up as a palliative against inequality and dropping incomes at the bottom. Surely, given that private indebtedness cannot simply increase as a % of GDP forever, it is something that is comment worthy. At some point, the bubble will strong growing.

    I’ve only read one chapter of this in article format but Crouch is rather good on the problems of sustaining demand through ever bigger private debt:

    http://www.amazon.co.uk/Strange-Non-Death-Neo-Liberalism-Colin-Crouch/dp/0745652212

    Sorry for a bit of scrappy response. Thanks for replying.

  6. March 26, 2013

    philip

    thank you – very thought provoking. Of course I agree tht private sector debt cannot increase for ever. The question really is whether borrowing is financed by saving, borrowing from abroad or money creation. As you might expect, I smell money creation at the bottom of a lot of the boom and bust episodes (more obviously in 1988-1990 than in 2005-2007 and, in the latter episode more obviously in the US than in the UK (which is not to say that there will not be private sector error – but then it is important for monetary policy not to compound that error).

    On think tank funding, my understanding is (and it is a case of don’t know rather than can’t say in terms of not being more specific) that before about 1995, free-market think tanks were well funded by a very broad range of businesses. That changed when businesses became more transparent. Of course, all publicly quoted businesses have to delcare when they give money to think tanks – so information is out there. However, we do respect donor confidentiality and, though no outsider would ever believe it, we also like the confidentiality aspect from the point of view of editorial independence. Though I know some donors personally and the amount they give (just through personal friendships) I have no idea who the vast majority of our donors are and as an academic running the output side, that is exactly how I like it. I think that all think tanks would quickly morph into contracted research (like IPPR – I may have over-stated their EU finding – and I do not criticise them for their model as long as they are up front) if they all published all their donors (not least because some individuals who like to keep all their charitable activity low key would be put off from donating and think tanks would have to obtain more tied funding (as has happened on both left and right since the reducion in corporate funding for think tanks)). You might be surprised at the low level of our donations about £0.75m a year I think . As it happens, as an acacemic with an ethical streak, i like the current arrangement. It may not survive forever, but I have a clear conscience, I work here because of what I believe (not the other way round) and we have to accept the quips that come from George Monbiot!

    I think the change with higher education will come for those who are at the margins of going to university (quite a big group). The model may change a bit for the top 20% say (more part-time courses, more two-year degrees, more under-graduate courses followed by a part-time online masters or professional courses). However, it strikes me that class sizes are already so big at many institutions that a move to online/distance learning part-time would be hugely better for many students paying £9K a year at places where students are much more taught and examined on very specific material. I might be wrong, but the organisations that do that (OU, BPP) seem to do it very well. In many senses, this would take us back to a modern version of what our parents would have done (nightschool courses taken at institutions that later turned from higher education colleges to universities etc). I am no entreprenuer, but, if i were, then establishing courses with a mix of online learning, telephone support and local tutorial support would be my guess at where the mass market will end up. I hope so, because i think it will be more rigorous in fact and actually allow people to get decent training and obtain work experience.

  7. March 31, 2013

    Tom B

    I’m glad you say private sector debt cannot increase for ever, though it is frustrating that think tanks and commentariat seem blind to the problem. The increases have massively outweighed public debt and the private sector deficits, as it were, have been huge for decades. The richest lending ever more to the poorest cannot continue and expand indefinitely. It would be nice to see something from the IEA on this problem, rather than on the Government debt issue alone.

    It is not just the problem of funding being opaque for think tanks. It is definitely the fact that they are treated as neutral experts rather than groups which have predictable stances on every issue, regardless of whether right or left.

    Just on the HE point, the class sizes in higher education are so big / have expanded for three reasons. Firstly, higher education policy in the 1980s incentivised universities to expand research but provided no extra funding overall. The results were decades of neglect for teaching. Secondly, higher education has expanded from 10% ish of age group in 1963 to 40% ish now. Thirdly, despite that increase, the level of spending has not kept up – up from 0.8% of GDP in 1960 to 1.2% now. Larger classes were the inevitable result of those three factors.

  8. March 31, 2013

    philip

    It being Easter, I am going to limit my response (I owe a private debt to my family so to speak!). In fact, I actually hope that we are not necessarily regarded as neutral but as contributors to discourse in a liberal society. We all have pre-conceptions that prevent us being entirely neutral. However, what I say on something is certainly never affected by our funding (in so far as I know who the funders are). We tend not to worry about private debt because it can resolve itself, I believe, in so far as it is not caused by loose monetary policy (but let’s agree to disagree on that). I agree with what you say about higher ed. and any distortions of the market in that way does leave providers open to competition in a more liberalised market. Whilst the very top universities need not worry, those lower down I think may well suffer hugely if they cross-subsidise research from teaching fees. They will be vulnerable to attack either by effective online providers or by colleges that put a lot of resources into teaching and do not use teaching fees to cross-subsidise relatively low quality research. My perception is that research is actually cross-subsidised internally (fear of falling out of the “champions league” rather than this wholly being a feature of money being directed more towards research by the government. The second quintile probably need new models of higher education that are focused on their teaching and I think it will happen at some stage. Happy Easter!

  9. March 31, 2013

    Tom B

    I did mean neutral as in without a material bias in favour of a certain approach, rather than neutral in terms of vacant. Happy easter and till your next blog no doubt!

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Philip Booth

Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs 




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