In the past few days we have had lost decades aplenty, apocalyptic warnings from the Bank of England governor, collective action by central banks to stave off a global liquidity crisis and a general sense of impending gloom.
People want to know, understandably, what it all means. For me it means we are looking at growth which is at best negligible over the next few months, followed by the beginnings of somewhat stronger growth in the second half of 2012.
But that path takes us past a dangerous hazard labelled “eurozone elephant trap”, the one we fall into if Sir Mervyn King’s warnings about inaction come about. And if we fall into it, no amount of contingency planning would save us from a nasty recession, possibly worse than 2008-9.
As if George Osborne did not have enough on his plate, he had to cope with people comparing him with Gordon Brown, because his Autumn Statement contained so many “tinkering” measures. I don’t suppose the former prime minister was too happy either.
I think it was a bit unfair, though some people remain keen to turn Osborne into Denis Healey, the Labour chancellor who tried to spend Britain out of recession in the 1970s, only to be forced to turn to the International Monetary Fund for a rescue.
As it was, had Osborne merely presented gloomy economic and borrowing forecasts without some compensating growth ideas, he would rightly have endured a political pummelling. Credit easing (getting more money flowing to small and medium-sized firms) and additional infrastructure spending are not “game changers” as the Treasury would have us believe but they are useful steps in the right direction.
Where the Osborne-Brown similarity works is that both of them have had to repeatedly admit that they were too optimistic on growth and borrowing. Brown’s optimism left an uncomfortable legacy for Alistair Darling and for the coalition.
Osborne’s retreat from earlier optimism could have more serious consequences for him. He cannot afford a further deterioriation.
This time he only met his fiscal rules by the flimsiest of whiskers, and only as a result of telling the independent Office for Budget Responsibility (OBR) that he would cut public spending in real terms for the first two years of the next parliament.
If the outlook for borrowing were to get worse, the chancellor would either be forced to pile austerity on austerity, by announcing further measures, or lose Britain’s AAA credit rating. This, already under closer scrutiny since the autumn statement, could easily go. If it went, Osborne would be honour-bound to go too.
Let me offer a couple of correctives to the gloom, not forgetting the elephant trap. The Institute for Fiscal Studies is marvellous and you criticise it at your peril. I think, however, it laid it on a bit thick with its “lost decade” (and more) for real household incomes. Paul Johnson, its director, said real median household incomes would be no higher in 2015-16 than in 2002-3, to which one can only say “Ouch!”
That is true on one measure. If we look at real household incomes in aggregate, however, the picture is less gloomy. It takes until 2014 to get back to the 2010 level of real incomes and the biggest fall – this year’s 2.3% drop – is behind us.
On a per head basis (the mean rather than the median), allowing for population growth, it takes longer: until 2016 to get back to 2009 levels, but short of a decade. Retailers who felt suicidal should come in from the ledge.
There were other elements of the OBR forecast that were less downbeat than
the headline-grabbers. The headlines were grabbed by the new forecast of 710,000 public sector job losses by 2017 (compared with a March forecast of 400,000 by 2016).
But the forecast is for these job losses to be more than offset by 1.7m of new private sector jobs. It also eventually expects growth to perk up quite well, hitting 3% before the next election.
The bigger question for the OBR, and the chancellor, is whether the watchdog has got a key technical call right. Back in April I wrote a piece on the importance of the output gap, spare capacity in the economy. It did not set many pulses racing.
It came to the fore, however, last week. Had the OBR come up with a different verdict on the output gap, Osborne’s strategy – eliminating the structural budget deficit by the next election – could have still been on course. There would have been no need for spending cuts beyond the next election.
So a technical judgment by the OBR, that there is just 2.5% spare capacity, has huge implications for politics, and for the hundreds of thousands more public sector workers whose jobs are now under threat.
The OBR, to its credit, runs an alternative scenario in which the economy has not been permanently damaged by the crisis and the output gap is 11% of the economy. Under those circumstances the deficit disappears as the economy grows.
That looks implausible. But 2.5% looks aggressively low. Every 1% reduction in the size of the gap increases the size of the structural deficit – which has to be tackled by spending cuts or tax hikes – by 0.7% of GDP, just over £10 billion.
The OBR points out that many forecasters have smaller estimates of spare capacity (though the OECD, National Institute and European commission are higher). It also notes that its estimates of spare capacity during the recession and its aftermath are historically high (though the latest recession was also much deeper).
This is hugely uncertain territory. The output gap is an economic concept that is almost impossible to measure. I share with Geoff Dicks, formerly of the OBR, the view that spare capacity is rather flexible, particularly in a service-based economy. It is easy to get people in to expand capacity in an estate agency or call centre and, as we know from the unemployment numbers, there are many people to get in.
I apologise for drifting into nerdy territory but this matters. The OBR’s judgment has consequences for people’s livelihoods. A watchdog would not be a watchdog unless its bites were occasionally painful. My worry is that, amid so much uncertainty, the OBR is inflicting additional and unnecessary pain on us.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post was originally published at David Smith’s EconomicsUK and is posted with permission.
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