Employment has risen. The economy is growing. The banks are better capitalised. The Treasury goes into Brexit from a position of strength, doesn’t it?
For obvious reasons George Osborne has made that observation already – see here and here. But his fiscal stance, for example, had already stored up a lot of trouble. There are more cuts to come over this Parliament, including £3.5bn in unidentified cuts that is yet to be divvied up across Departments. More than that, the Conservative manifesto commitments to increase the personal tax allowance and the income threshold for the 40p rate are not costed into the plans he left behind.
Even with a growing economy, eliminating the deficit by the end of the Parliament looked improbable.
After the Leave vote, this is off the table anyway. It’s time for a new fiscal strategy. Austerity is over, right?
Our early calculations – based on new GDP forecasts from independent economists after the vote – suggest that deficit reduction will certainly ground to a halt. But this only takes into account the effect of lower tax revenues due to lower growth. Ending austerity – in the sense of stopping cuts to government budgets – will mean that the deficit starts to rise again. If there is to be a fiscal stimulus on top then in the short term at least government will be borrowing a lot more than the Treasury had planned.
Isn’t there an economic consensus now that this is the right thing to do?
Mark Carney, the Governor of the Bank of England, has certainly indicated that he expects some fiscal complement to the monetary stimulus that he haslaunched in the wake of the Leave vote. Many independent economistssupport that view.
Though there are some hawks that maintain deficit reduction should continue. If the deficit starts to rise in a major way, they and Conservatives who agree with them will speak out. Inconveniently for the Government they will be able to point to several past Treasury documents that warn of the risks of a rising deficit e.g. Section B of Budget 2014.
What could a fiscal stimulus be used to fund?
Typically the Treasury will argue that it should be used for projects that increase productivity. Though if the aim of a stimulus is equally to boost economic activity in the short term then it’s no good picking projects that are great in theory but can’t get started for a number of years.
But here lies a problem. The head of the National Audit Office has recentlywarned that the Government is already over-extended, even before the task of Brexit, never mind trying to get lots of new projects off the ground quickly.
Even if the economic case – and political desire – to fund big new infrastructure projects is there, the Treasury might have to advise Ministers that they can’t be delivered.
What’s the alternative?
This may be where an industrial strategy comes into its own. Some private firms may be better placed to deliver investment plans. Government could give them money to get on with it. This is fraught with difficulties – for example, perhaps the project might have gone ahead without taxpayer support, or if it needed taxpayer support then perhaps it isn’t the best value for money.
But these objections may carry less force when there is a slowdown in economic activity and perhaps especially if the projects chosen are in parts of the country which have grown more slowly in the past. Using an industrial strategy to build out UK supply chains might be another smart choice – boosting the capacity of exporters when they can also get some play from a cheaper pound and reducing the imports they buy to produce finished goods.
Will that be enough?
The Bank of England forecasts that, following the measures it has announced, the UK will narrowly avoid a recession. More Government spending could help to ensure that this is the case.
Another contender for stimulus will be big science projects. The Treasury under Osborne was persuadable on these. Though it’s not only Osborne that’s gone. John Kingman – the Second Permanent Secretary who led the Northern Powerhouse programme and was often influential on science decision-making – has left as well. That said, already in his new role as Chair of UK Research and Innovation, he has been speaking up for the importance of spending on science.