Medium-term prospects for the UK and the world: thoughts on the Autumn Statement


George Osborne

The UK government’s ‘Autumn Statement’ on the public finances was delivered this week. It contained a curious mixture of both real and superficial U-turns. On the former, the Chancellor of the Exchequer, George Osborne, outlined plans to raise taxes and spending over the next fiver years more than promised in the run-up to May’s general election. On the latter, he scrapped plans to cut tax credits, an in-work benefit for the low paid, although the new Universal Credit, which is gradually replacing tax credits, will be less generous once it is introduced fully, hitting some of the poorest workers about as hard.

What I want to briefly concentrate on here is Osborne’s plan to run a budget surplus, that is an excess of receipts over expenditure, or tax revenues over spending, by 2020. Running a surplus under ‘normal’ economic conditions is to become law, although of course this could be overturned by any future government if deemed necessary.

Osborne argues that running a budget surplus in normal times will allow the national debt to fall, so providing hard-working families with ‘economic security’ (the latest policy catch-phrase, which will no doubt be repeated ad nauseam in the months ahead by leading conservatives). But in fact, if we assume that it is indeed desirable to reduce the national debt as a proportion of GDP at whatever cost, this could still be done while running a small deficit, as long as nominal GDP (growth plus inflation) is growing at a rate greater than the size of the annual deficit, plus interest costs on the overall debt. And if the borrowing represented by the deficit is used explicitly to invest in infrastructure, research and development and other sources of future economic growth and tax revenues, then the whole rational for a surplus is revealed as a myth and even an act of poorly informed stupidity. In fact, virtually no economist has come out in support of Osborne’s plan and many have come out against it, although this does not seem to have been communicated by the media.

The Chancellor has announced plans for increased spending on infrastructure, but after public investment was cut so severely by the last Labour government at the end of its time in office, as well as the Conservative-led 2010-2015 coalition, there is much ground to make up and the current plans remain inadequate.

Aside from the myth of the need for budget surpluses to pay down debt and promote prosperity, there are certain macroeconomic constraints facing the UK which could derail the plan over the medium term. They could also threaten financial stability and, yes, economic security!

The constraints are the need for the current account to improve as the budget deficit falls towards balance. If it does not, then economic growth can only be sustained by a rise in the accumulation of private debt. If the current account is still around 4% of GDP in 2020 and the public budget is in surplus to the tune of 1%, then private borrowing will need to be growing at 5% a year in order for growth to continue. If this is faster than nominal GDP growth, it will prove unsustainable and will eventually have to be reversed.

Given slowing world economic growth, particularly in emerging markets, and a sluggish eurozone, UK exporters may find it hard to significantly expand markets and help to reduce the current account deficit over the next few years. The contribution of net investment income on the current account may also continue to be weak. If foreign trade and investment income performance do not improve, then we face either a weakening economy, or excessive growth in private debt that could once again threaten to lead to a new financial crisis and economic downturn if and when households and firms start to reduce their indebtedness.

The sustainable solution to these potential financial and economic threats is somewhat out of the UK government’s hands. Those major economies running substantial current account surpluses need a boost in domestic demand and a fall in savings relative to investment to reduce these surpluses. They especially include Germany and China. Rebalancing in Germany would significantly help the rest of Europe out of its economic malaise, and a recovering eurozone relative to the UK would help to realign the euro-sterling exchange rate, since relative improvements in economic performance tend to boost the value of the currency.

A weaker pound vis-à-vis the euro and faster growth across Europe would help to boost UK net exports, along with net investment income from that region. Policies which help to promote UK trade performance can lay the foundations for such a boost to be realised if world trade were to recover from its current sluggishness. UK firms need to be ready to capture significant shares of expanding world markets and the government can help this to be achieved. Judging from the Autumn Statement, it seems to be doing too little.

A sustained world economic recovery requires this kind of rebalancing between nations, and in the absence of global cooperation, as seems likely at the moment, domestic reforms, particularly in Germany and China, are a key part of finally leaving the legacy of the 2008 financial crisis and recession behind. Until the next one of course!


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