Hammond is playing a high stakes game with the economyby George Magnus / November 1, 2018 / Leave a comment
While the chancellor was delivering the Budget statement earlier this week, a friend sent me a text message reading “Where did he get all this money from?”
It was a great question. Without the extra money, the government would be up its Brexit creek without so much as a pooh stick, let alone a paddle. It is a windfall the government did not expect. Instead of using it to balance the budget and start to pay down debt, Philip Hammond returned it to the country, mostly in the form of higher NHS spending. While he still plans to bring the deficit down to a low level and reduce debt as a share of GDP in the next five years, the hallowed balanced budget has dropped out of the forecast horizon even though, cyclically adjusted, the budget is in small surplus throughout.
Yet the windfall could also be fleeting, we just don’t know, and neither does the chancellor. If it were, the consequences could be explosive.
The government has been lucky. The politics of budgetary policy started to change before it had any inkling of its good fortune. Coinciding with the 70th anniversary of the founding of the NHS in early July, the prime minister announced the big boost in NHS spending the chancellor just confirmed. As parliament shut down for the summer holidays, the government lifted the public sector pay cap that had been held for five years at 1 per cent. The political rhetoric about austerity began to change, until the prime minister announced its end formally at the Conservative Party conference in early October. By then the government was almost certainly aware of good news from the Office for Budget Responsibility.
In a nutshell, the OBR told the government that borrowing in 2018-19 would be about £11.9bn lower than expected thanks mainly to stronger tax revenues. And even better, that the improvement in the profile for tax revenues wasn’t a one-off. Thanks to a revised outlook for sustainably lower unemployment, higher labour force participation and inflation, and higher growth in the money value of GDP, tax receipts, especially of National Insurance contributions, corporation tax and VAT would remain buoyant. The cumulative improvement in tax receipts by 2022-23 is predicted to be around £83bn, which the OBR hailed as one of the biggest fiscal swings in recent times.
NHS spending will now account for four-fifths of the additional public spending predicted over the next five years. In real terms (adjusting for inflation), it is now predicted to rise by over 3 per cent per year, so that by 2023-24, it’ll be 20 per cent higher than in 2015-16. Welcome though this is, it isn’t a substitute for a serious discussion about how we are going to fund healthcare in an ageing society, which, according to the Institute for Fiscal Studies, is expected to have grown from 23 per cent of public spending in 2000 to 38 per cent by 2023-24. For this, one unavoidable outcome will be that we all have to pay more.
Yet when it comes to other public services—including local government, police and prisons—austerity has been eased but not ended. Except for defence, aid, and some schools and capital spending, for example, real outlays are barely going to change for the foreseeable future. The chancellor has built into his plans a £15bn fiscal buffer to help deal with any adverse fall-out from Brexit, and has more than hinted that if everything goes fine in the Brexit process—whatever that means—that this and better growth prospects could then help to fund further increases in public expenditure, and lower taxation.
The NHS spending boost, the suggestion of further fiscal easing, and the tax and benefit measures the chancellor also announced this week are not an economic strategy to boost economic growth much, improve income distribution, or change the structure of the economy. But they do constitute important elements in a political strategy. Before this week, the government had in effect weaponised deficit control to bolster its reputation for fiscal discipline, and put Labour continuously on the defensive. This gun has now been spiked. Instead, the government is championing the end of austerity, and the prospect of better times ahead for three reasons.
First, to increase its appeal to voters in the event that circumstances should result in an early election. Second, to bolster the political capital of the prime minister in the face of internal opposition. And third, perhaps above all, to neutralise enough Brexiteer rebels in the Conservative Party to help the yet-to-be finalised Brexit deal through parliament. Put more plainly, the government is warning its Brexit rebels that if they do not fall into line, a no-deal outcome would throw the government’s entire economic and fiscal strategy to the wolves.
As the Chancellor, OBR, IFS and everyone else has stated, if the nation crashes out of the EU next March, the consequences for the economy, sterling and UK financial markets are likely to be dire. They may well involve a protracted recession. In any event those additional tax receipts would disappear as fast as they were found. The government would have to take back some of its just-announced largesse, but it would be unable to raise taxes materially, and the climate for cutting back public spending would be toxic. The only alternative would be watch helplessly as the government deficit, borrowing and debt all lurched higher again. It would make no difference who was living at 11 Downing Street. The IFS called Hammond’s strategy “a gamble.” We better hope it pays off.