Hammond ditches the good bits, and keeps the bad bits of ‘Osbornomics’
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 (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.
 There are some inconsistencies in the data, but this is a reasonable estimation of the situation.