Labour is presenting itself as the new party of fiscal responsibility, with a “Budget Responsibility Lock” to prove it. Its manifesto only includes spending commitments that are paid for by cuts or tax rises elsewhere.
But whilst it is not making unfunded promises of new spending, it is not saying a great deal about any substantial spending cuts that would make a contribution to improving the public finances. In the Q&A at Labour’s manifesto launch, Ed Miliband said that there would be some cuts after 2016, but did not say how much. That is in sharp contrast to the Conservatives who have talked about the amounts they plan to raise by cutting welfare and spending by Government departments.
The reason is that – on paper at least – Labour are in a pretty good position. If the OBR forecasts are correct, tax revenues will grow by around 14% in real terms in the next Parliament, as incomes continue to recover. That growth in tax revenues does a lot of deficit clearing all on its own. And given that Labour is only targeting the current deficit, which excludes investment spending, Labour could end austerity after 2015-16 and still hit this target by the end of the next Parliament.
But there is a big “if” here. The OBR is expecting productivity growth to pick up, allowing wages to rise. If workers are able to produce more output, then firms can afford to pay them more, meaning more money raised in taxes.
The UK economy trails behind countries like France, Germany, the US and even Italy, in the amount produced per hour worked. Yet there is little consensus on why the UK has fallen so behind in recent years, and the OBR has been disappointed in its forecasts of productivity growth before. Output per hour actually fell at the end of 2014. And there are plenty of sources of global uncertainty that could give the UK economy an unexpected knock in the next few years.
If productivity growth does not improve on what we have seen over the last few years, then spending and revenue forecasts could be out by tens of billions. Poor growth is the key reason why the current Government failed to eliminate the deficit by 2015 despite implementing its spending cuts programme. If something similar happens again, even a Labour Government would still need to make big cuts to continue to meet deficit reduction commitments. As the SMF has previously argued, the next Government needs to make growth its top priority, putting it at the forefront of all decisions, including spending.
This all means that Labour’s fiscal credibility depends on the strength of its policies to boost business growth. Its manifesto talks of boosting long-term investment, supporting infrastructure projects, and giving young people the skills they need. A future Labour Government had better hope that that’s enough.