Hammond ditches the good bits, and keeps the bad bits of ‘Osbornomics’
3 October 2016
SUGGESTED
Government and Institutions
Tax and Fiscal Policy
Trade, Development, and Immigration
4 November 2024
Pragmatism was the order of the day at Conservative Party conference today – especially from the Chancellor of the Exchequer, Philip Hammond. Apparently, his predecessor, George Osborne, in seeking to balance the budget 12 years after the financial crash and four years after we have reached record employment levels, is a dangerous ideologue.
It is worth reminding ourselves about the pragmatic deficit reduction course that Osborne followed. This table shows the deficit since 2009/10 (selected years) and projected until 2019-20 as a percentage of national income.
The UK has the fifth highest deficit in the OECD[1] (after Greece, Japan, Portugal and Spain, none of which we would want to emulate). What is more alarming – though it should demonstrate Osborne’s pragmatism to Hammond – is the optimistic nature of the government’s forecasts. So, when judging the likely outturn in 2020, we should note that, in November 2010, the government forecast the 2014-15 deficit to be 1.9 per cent of national income.
This all means, of course, that the government’s debt is not only rising in nominal terms, but has only just stabilised (and has stabilised precariously) as a proportion of national income. And this is all at a time nine years after the original emergency and when unemployment is low and employment at record levels.
Fine tuning – we have been here before (that is before we finished six weeks of the A-level macro course)
But what is truly concerning are his justifications for borrowing more. Firstly, he wishes to borrow more because business is reducing its investment following the Brexit vote. Well, we shall see. However, increasing government borrowing for this purpose is based on three assumptions, all of which are highly contestable and probably wrong.
The first is that the government can fine tune the economy to somehow compensate for a loss of private spending. As Prof. Frank Paish said, this is rather like driving a car looking in a rear view mirror on a rather windy road with a long lag between pressing the brake or accelerator and anything actually happening. To cap it all, the rear view mirror is rather misted up. The idea that discretionary fiscal policy can be used to steer the economy to avoid the problems caused by small changes in private sector demand is one that belongs to the 1970s. It is even challenged in what used to be AS-level economics (sadly abolished by Michael Gove).
Secondly, there is an assumption that public and private sector investment are simply substitutes for each other. However, public sector spending cannot simply be used to replace private sector spending. The land, labour and capital required for public sector investment are not the same as the land, labour and capital required for private sector investment – the investment is in different things. Aggregate demand is not one homogenous lump and aggregate supply is not either. The government spending that replaces private spending requires different factors of production specialising in and trained in different activities. Thus the additional public spending simply pulls the economy out of shape and defers any recovery caused by the fall in private spending. It is surprising, after the Japanese have tested Philip Hammond’s ideas to destruction, that he now wants to try them out on the people of the UK.
Finally, government borrowing has to be funded. Open economies with floating exchange rates do not have significant positive fiscal multipliers. If capital is not attracted from other parts of the domestic capital market, it is sucked in from overseas and the real exchange rate rises, thus reducing exports. For countries that are already highly indebted, the situation is worse. Also, the more indebted a country is, the more likely it is that people will rein in their consumer spending if government spending increases because it will be known that the so-called fiscal expansion will have to be reversed rapidly with an increase in taxes. The best that can happen from a so-called fiscal expansion in current circumstances is a very temporary boost to growth, followed by a rapid slowdown as the brakes are put on just as we start crawling out of recession.
Perhaps even more remarkable is the idea that the government should be borrowing money to spend money on housebuilding. Governments do not have to build houses. Giving planning permission in the South East will raise the value of land about 450-fold. Developers are not deliberately missing out on such profits, they are being prevented from making them. Hammond could solve all his problems (and many more) by allowing private investment to increase post-Brexit through persuading the rest of the cabinet to liberalise planning laws.
Reverse the wrong Osborne policies not the right ones
Hammond’s proposals are a serious misjudgement. It is a pity, because there is a big part of Osborne’s legacy that needs to be jettisoned. Osborne used budgets for nakedly political purposes and, in doing so, created enormous complexity in the tax code whilst undermining business. The clearest example of this relates to his tax changes for buy-to-let properties, followed closely by the Apprenticeship Levy. Philip Hammond could use a whole budget doing nothing other than reversing misguided Osborne policies. Unfortunately, he seems to be set on reversing one of the few parts of the Osborne agenda which actually had some merit.
[1] There are some inconsistencies in the data, but this is a reasonable estimation of the situation.
It is worth reminding ourselves about the pragmatic deficit reduction course that Osborne followed. This table shows the deficit since 2009/10 (selected years) and projected until 2019-20 as a percentage of national income.
The UK has the fifth highest deficit in the OECD[1] (after Greece, Japan, Portugal and Spain, none of which we would want to emulate). What is more alarming – though it should demonstrate Osborne’s pragmatism to Hammond – is the optimistic nature of the government’s forecasts. So, when judging the likely outturn in 2020, we should note that, in November 2010, the government forecast the 2014-15 deficit to be 1.9 per cent of national income.
This all means, of course, that the government’s debt is not only rising in nominal terms, but has only just stabilised (and has stabilised precariously) as a proportion of national income. And this is all at a time nine years after the original emergency and when unemployment is low and employment at record levels.
Fine tuning – we have been here before (that is before we finished six weeks of the A-level macro course)
But what is truly concerning are his justifications for borrowing more. Firstly, he wishes to borrow more because business is reducing its investment following the Brexit vote. Well, we shall see. However, increasing government borrowing for this purpose is based on three assumptions, all of which are highly contestable and probably wrong.
The first is that the government can fine tune the economy to somehow compensate for a loss of private spending. As Prof. Frank Paish said, this is rather like driving a car looking in a rear view mirror on a rather windy road with a long lag between pressing the brake or accelerator and anything actually happening. To cap it all, the rear view mirror is rather misted up. The idea that discretionary fiscal policy can be used to steer the economy to avoid the problems caused by small changes in private sector demand is one that belongs to the 1970s. It is even challenged in what used to be AS-level economics (sadly abolished by Michael Gove).
Secondly, there is an assumption that public and private sector investment are simply substitutes for each other. However, public sector spending cannot simply be used to replace private sector spending. The land, labour and capital required for public sector investment are not the same as the land, labour and capital required for private sector investment – the investment is in different things. Aggregate demand is not one homogenous lump and aggregate supply is not either. The government spending that replaces private spending requires different factors of production specialising in and trained in different activities. Thus the additional public spending simply pulls the economy out of shape and defers any recovery caused by the fall in private spending. It is surprising, after the Japanese have tested Philip Hammond’s ideas to destruction, that he now wants to try them out on the people of the UK.
Finally, government borrowing has to be funded. Open economies with floating exchange rates do not have significant positive fiscal multipliers. If capital is not attracted from other parts of the domestic capital market, it is sucked in from overseas and the real exchange rate rises, thus reducing exports. For countries that are already highly indebted, the situation is worse. Also, the more indebted a country is, the more likely it is that people will rein in their consumer spending if government spending increases because it will be known that the so-called fiscal expansion will have to be reversed rapidly with an increase in taxes. The best that can happen from a so-called fiscal expansion in current circumstances is a very temporary boost to growth, followed by a rapid slowdown as the brakes are put on just as we start crawling out of recession.
Perhaps even more remarkable is the idea that the government should be borrowing money to spend money on housebuilding. Governments do not have to build houses. Giving planning permission in the South East will raise the value of land about 450-fold. Developers are not deliberately missing out on such profits, they are being prevented from making them. Hammond could solve all his problems (and many more) by allowing private investment to increase post-Brexit through persuading the rest of the cabinet to liberalise planning laws.
Reverse the wrong Osborne policies not the right ones
Hammond’s proposals are a serious misjudgement. It is a pity, because there is a big part of Osborne’s legacy that needs to be jettisoned. Osborne used budgets for nakedly political purposes and, in doing so, created enormous complexity in the tax code whilst undermining business. The clearest example of this relates to his tax changes for buy-to-let properties, followed closely by the Apprenticeship Levy. Philip Hammond could use a whole budget doing nothing other than reversing misguided Osborne policies. Unfortunately, he seems to be set on reversing one of the few parts of the Osborne agenda which actually had some merit.
[1] There are some inconsistencies in the data, but this is a reasonable estimation of the situation.
2 thoughts on “Hammond ditches the good bits, and keeps the bad bits of ‘Osbornomics’”
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It is perfectly laudable to seek to use subsidies funded by the Public Sector to invest in public works, as part of a modern Industrial Strategy.
Indeed, some people have argued that money can be borrowed by the Government, at a time when interest rates are a record low, and spent on infrastructure projects to create jobs, invigorate the economy and boost productivity. Of course, such a move would be a great idea – if, this borrowed money were paid back over the next several years.
However, the fact of the matter is that it will simply be added to the burgeoning national debt (currently at £1,700 billion) and only paid-off during the lifetime of today’s millennials, their children and grandchildren – thereby transferring this burden onto future generations. It is morally wrong to foist debt onto citizens who are not yet born, and force them to pay the price for the irresponsible behaviour and excesses of those in charge of public policy today.
It is not so much hesitancy on the part of elite politicians in Westminster that is stalling decisions on key infrastructure projects like HS2 and Heathrow, but a lack of confidence in the ability of civil servants in Whitehall to agree taut commercial contracts with Private Sector players, which will secure best value for money for taxpayers’ money over the long term – no one in Government wants to even mention this in public, least they blurt out the truth.
Notwithstanding the spin from the Government regarding the superlative capabilities of its technical and commercial staff, the reality on the ground is that they are woefully ill-equipped to deal with the Private Sector – it remains the single most important constraint which is holding back politicians from committing public funds!
Additionally, there is concern in some quarters that Government/Industry forums, which are the formal mechanism for discussing these sorts of issues, will be hijacked by those with superior negotiating skills like big business, to swing spending decisions in their favour – side stepping the interests of others like, small and medium-sized enterprises who are seen as the lifeblood of the UK economy and should rightly be given equal access to publicly-funded contracts.
@JagPatel3 on twitter
I don’t agree entirely with what you say (but much of it I do agree with), but putting that aside, one thing I would say is that, once the government has dealt with planning issue, the building of a runway should be left up to the airports. There should be no need for contracts.