As four years of the Coalition approach on 11th May, this week we examine its record to date in five key policy areas. In the second piece in the series, Graeme Leach and Harriet Maltby assess the Government’s performance on economic policy.
Graeme is Director of Economics at the Legatum Institute, where Harriet is a Government & Economic Policy Researcher.
It’s June 2010, and the newly appointed Chancellor steps up to the despatch box; “Mr Deputy Speaker, today I will unveil to the House the most radical Budget in British economic history”.
Every Chancellor surely dreams of speaking those words and instantly grabbing the attention of the House of Commons and the country. But every Chancellor has to play with the hand he’s been dealt. George Osborne could never utter those words because he’d been dealt a very bad hand.
Four years on, we tend to forget that the fiscal austerity package was needed to counter a 9 per cent of GDP deterioration in the public finances – as a result of the financial crisis and recession, which had seen the economy contract by 5 per cent in 2009.
It was common talk at the time that within months the Chancellor would become the most unpopular man in the land. The fact that it didn’t turn out that way is probably the result of the sense of national economic crisis, which prevailed at the time, and also the perceived political consensus – with a Liberal Democrat Chief Secretary to the Treasury – from the formation of the Coalition. This all helped the Chancellor (and Coalition) to win the ‘Battle of Austerity’ in the media.
So looking back to 2010, what did the Coalition Agreement and June emergency Budget set out to achieve?
The major economic commitments were:
- To implement a significant acceleration in the reduction of the structural deficit over the course of the parliament, with the main burden of adjustment falling on lower spending rather than higher taxation.
- To implement a forward-looking fiscal mandate and achieve cyclically adjusted current balance by the end of the rolling 5-year forecast period (to 2015-16). The fiscal mandate was based on the current balance (to help shield public investment) and cyclically adjusted (to allow some flexibility in the face of economic uncertainty).
- To supplement the fiscal mandate, set a fixed date of 2015-16 for when public sector net debt (as a proportion of GDP), as a proportion of GDP, would be falling by i.e. by the end of the fixed term Parliament.
- To raise the personal allowance to £10,000 over the course of the Parliament.
- To reduce the main rate of Corporation Tax from 28 per cent to 24 per cent over 4 years from April 2011.
- To avoid further reductions in public sector capital expenditure (beyond the reductions identified in 2010-11).
- To rebalance the economy from the public to the private sector, both in terms of output and employment.
- To rebalance the economy across regions and industries.
- To double exports to £1 trillion by 2020.
So how has the Coalition performed subsequently?
Comparison with Labour: Without the June 2010 Budget measures (in other words, had they continued the previous Government’s fiscal stance), the OBR forecast that public sector net borrowing would, by the end of the Parliament, remain at 4% of GDP, the structural current deficit would be at 1.6 per cent of GDP and public debt would peak at 75 per cent of GDP.
By the March 2014 Budget the OBR were predicting public sector net borrowing (excluding Royal Mail transfer effects) of 5.5 per cent of GDP by the end of the Parliament. They were also predicting the structural current deficit to be 2.9 per cent of GDP by the end of the Parliament and public debt would peak at 79 per cent of GDP.
At first sight, the Coalition would appear to have performed worse than Labour would have, but such an assertion would be wrong. Firstly, we don’t know what Labour would have done had they remained in power. They could have implemented all manner of policies, good or bad. Secondly, GDP growth has been weaker than was expected (over 2010-13 the June 2010 Budget predicted 2.3 per cent average growth, but the outturn was nearly half this rate at 1.2 per cent).
Much of this deterioration was beyond the control of the Coalition (although people will continue to argue about the rights and wrongs of austerity for years to come), due to the impact of the Euro crisis and the scale of deleveraging in the UK banking system. Bank balance sheets had tripled in size in the five years up to the financial crisis and a massive deleveraging exercise was under way when the Coalition came to power. Neither factor was really incorporated into HM Treasury forecasts in 2009-10.
Comparison with the Coalition’s stated objectives: Taking the last full fiscal year of Labour (2009-10) as the start point and the last full year of the Coalition as the end point (2014-15), the June 2010 Budget forecast – by the OBR – predicted a turnaround in the cyclically adjusted current budget from a deficit of 5.3 per cent of GDP to a surplus of 0.3 per cent of GDP.
The latest projections from the OBR show a deficit on the cyclically adjusted current budget of 2.9 per cent of GDP in 2014-15 and no move into surplus until 2017-18. So balancing the cyclically adjusted current budget by 2015-16 is unlikely.
Public sector net debt was forecast to increase from 54 per cent of GDP in 2009-10 to a peak of 70 per cent of GDP in 2013-14, before declining to 69 per cent of GDP in 2014-15. The OBR now expects public sector net debt at 77.3 per cent in 2014-15 (i.e. nearly 8% of GDP more than expected) with a projected peak at 79 per cent of GDP in 2015-16. Public debt is projected to decline thereafter and consequently, in the run up to the General Election, the Coalition could be able to say that it is satisfying this element of the fiscal mandate.
Public sector net borrowing in 2014-15 was forecast at 2.1 per cent of GDP in the June 2010 but is now projected to be at 5.5 per cent of GDP. So on the headline deficit measure (excluding the effects of the Royal Mail transfer) the Coalition has performed far worse than the OBR projected in June 2010. However, the Coalition can defend itself on the grounds that it didn’t target this measure.
The key question is what was the source of the worse than expected performance, when compared with June 2010. We suggest that much of it was driven by economic circumstances largely beyond the Government’s control: First, the impact of the euro crisis on consumer, business and financial confidence in the UK. Second, the impact of bank de-leveraging on the money supply. Despite quantitative easing broad money supply M4x has struggled to increase at all at times, and even with the acceleration in M4x growth over the past 18 months, is still below the Monetary Policy Committee’s 6-9 per cent growth target range.
But this is not to let the Coalition off the hook. If there was a real will to reduce the size of the state, spending could have been reduced further and faster. The Coalition has been about deficit reduction, reducing the size of the state itself was not the primary strategy. Consequently we’ve had a mixture of salami slicing and ring fencing instead of a root and branch re-appraisal of the role and limits of Government. You don’t get many opportunities (thankfully) to make good use of a crisis. This was the opportunity to articulate a small Government Big Society future, but they fluffed it.
In other areas, the Coalition can claim to have exceeded its stated aims, for example with the increase in the personal allowance to £10,500, announced in the March 2014 Budget. It has also significantly exceeded expectations with the reduction in the main rate of Corporation Tax to 20 per cent from April 2015.
That said, Coalition politics have left two big tax problems unresolved. The reduction in the top rate of Income Tax to 45 per cent should have gone all the way to 40 per cent, and beyond. What’s more, the removal of the personal allowance at £100,000 results in a 62 per cent marginal rate, an utter absurdity imposed on some of the most productive workers in the economy. We’re in a situation where the top 1 per cent of earners now pay just under 30 per cent of all tax. Further down the scale, the use of fiscal drag to put more and more taxpayers into higher bands is also very bad.
With regard to the impact of welfare reform, hopes were high, confidence has weakened, but the jury is still out. There is a lot of anecdotal evidence that a tougher approach is yielding results and boosting employment, but the Coalition is also sending out mixed messages on welfare. One day it commits to a cap on welfare; the next day it stresses the state pension is outside the cap and reaffirms its commitment to the triple lock.
Despite some supply-side boosts, there have still been bad decisions and indecision elsewhere.
The housing market needs help to supply, but it’s had help to buy instead. More people will get on the housing ladder, but they will pay far more for the privilege. The risk is that politicians and the electorate could get hooked on this interventionist drug. One can hear Sir Humphrey asking: “If prices went up when we introduced it, what will happen if it is withdrawn? Minister, that would be a brave decision.”
The lack of a decision on Heathrow damages the economy every day, and the economic case for HS2 is doubtful. It’s a lot of money for a railway which will probably never get beyond Birmingham.
On the regulatory front progress has been glacial. Similarly, the pace of change in terms of rebalancing the economy, both sectorally and regionally, was never a job for a single parliament, and progress has been predictably slow. Financial services have shrunk, but that’s not great when parts of the sector had created so much value added in the past, and there is a permanent loss of output.
Regionally, we still look and feel like two nations – London and the South East, and then the rest. But if we’re going to unleash growth further North and West, we have to reduce the size of the state and release resources into the faster growing, more productive private sector.
As has often been said, productivity isn’t everything, but it’s nearly everything. Compared with 2010, output per job across the whole economy is up just 0.5 per cent, while output per hour is down 1.1 per cent. On the plus side, stronger economic growth has raised employment (with private sector gains exceeding public sector losses) but productivity is only now beginning to kick-in. This may save the day electorally.
The Coalition’s economic report card reads: Inherited a difficult situation and did well to stabilise it. Exceeded expectations at times, but disappointed as well. Even allowing for coalition tensions, could have done better. 6/10.