Andrew Lilico is Executive Director and Principal of Europe Economics.
A week today, Philip Hammond will present the Autumn Statement, his first major set-piece event since taking over as Chancellor. This gives him the opportunity to set out not only how the Government will respond, economically, to Brexit, but also to circumscribe his own economic philosophy more generally.
Here I would like to reflect a little upon what he might and should say on the following issues: the deficit; infrastructure; “Industrial strategy”; housing; trade/tariffs; financial services; the CAP; and green policies more generally.
George Osborne never met his deficit reduction targets, and wasn’t going to meet his latest ones even if we had remained in the EU. Even for 2016, despite GDP growth being pretty close to the Budget’s forecast, tax receipts are well down. As for Osborne’s projection that there was going to be a large amount of extra deficit reduction in the final year before the 2020 General Election…
Hammond will not only have a new set of forecasts; he’ll probably also announce a new set of fiscal targets. My recommendation would be to abandon the hubris of setting targets for three or five years. I don’t believe we need them at this stage. Better to just signal a vague ambition to get the deficit down and to keep it at a sensible and sustainable level by historical norms (without specifying a precise deficit to GDP that that implies. The best deficit to GDP ratio will depend upon the UK’s sustainable growth rate over the medium-term and upon how the economy performs in the period around Brexit, and we just don’t know at this stage about either of those things) and set a specific target only for this year and next year. The deficit’s still a bit high, so we need spending to fall a bit more relative to GDP, but the fiscal situation is broadly okay and not much active management is required.
As for infrastructure, in my view each scheme should stand or fall on its own merits. People are once again talking of “kick-starting” the economy via infrastructure spending. But UK growth has been fine in recent years. We don’t need to “kick-start” anything. Indeed, with Brexit-related medium-term uncertainty rather high, it’s an inauspicious time to be investing in grand schemes: there’s every chance of wasting money on white elephants at times like this. If anything, I’d be looking to cut back on things like HS2 and focus instead on more mundane schemes.
One area the government might do a bit more on is housing. There’s no “housing crisis” as such – we’ve ample houses for the number of households we have now – but there’s probably some scope for implementing some of those housebuilding schemes that Cameron talked of but struggled to deliver upon. One interesting area is Osborne’s reorganisation of local government pension schemes into six “British wealth funds”, intended to invest much more in private housing construction. It would be nice to hear more of how that is proceeding.
Once we leave the EU, the government will once again have responsibility for tariffs. Maybe during future Budget speeches we’ll be listening out for the latest tweak to the tariffs on Australian wine just as keenly as to tweaks on fuel duty or corporation tax. We cannot expect Hammond to be setting out a detailed new schedule of post-Brexit tariffs this time, but it could be useful for him to give some general sketch of emerging thinking. We surely will be leaving the EU Customs Union, at least in respect of most products. Does the Government have a general aspiration to have lower tariffs on non-EU products than the EU has imposed for us up to now? Or does it see tariffs on non-EU products as primarily a negotiating weapon in new post-Brexit trade agreements? I’d recommend signalling a general appetite for lower tariffs than the EU imposes, but not a commitment to unilateral free trade (at least not yet).
The Treasury is leading the Brexit negotiations in respect of financial services. What can Hammond share with us about that? Is the Government seeking EU passports for financial sector firms? Or is it expecting to achieve much the same result via being deemed regulatorily equivalent to the EU? If the latter, is it seeking to extend the EU’s current framework of regulatory equivalence to areas currently not covered, such as deposit-taking? What new flexibility for financial services does the government expect Brexit to provide? Have we come to the end of banker-bashing and bank levies? Will Hammond have anything to share with us about when the Government’s remaining shares in banks might be sold? I’d recommend talking up regulatory equivalence, no new bank levies, and no rush on disposing of bank shares, this time.
Most commentators talk of the three “Brexit ministers” – Foreign Office, Trade and Minister for Exiting the EU. But I think there are really four: the Common Agricultural Policy still takes up 40 per cent of the EU’s budget, the UK has never approved of it, and the EU and UK are most unlikely, in my view, to be able to come to any accommodation on agriculture. The UK will be completely out of the CAP, from the moment we leave the EU, and will face full EU tariffs. What will we be doing instead? Andrea Leadsom’s team is presumably working hard on a new British rural policy to replace the CAP, but there will be key questions that will ultimately be for the Chancellor. In particular, I hope we have no intention of reciprocating what will be very high tariffs on agriculture imposed by the EU, and that any agriculture tariffs we retain will be quite targeted, and perhaps even only transitional. We will want food prices to drop, post-Brexit, as tariffs on non-EU products come down, to offset inflation elsewhere. We do not want that effect negated by tariffs being imposed on food from the EU.
Last and perhaps connected to the rural economy issue, Hammond should indicate something of his thinking on environmental policies. Osborne largely abandoned green fiscal policies in the 2015 Budget. With Trump’s victory in the US Presidential election and the Republicans controlling both chambers of Congress, it’s pretty clear that, as Mark Wallace indicates on this site today, the Paris Accord is done and global climate change action altogether is pretty much finished for the foreseeable future. I believe the British government should embrace that as a new reality and engage in a major switch of its climate change policies away from incentivising mitigation measures (which have proved futile), instead creating a new system of incentives (tax reliefs and subsidies and R&D incentives) to encourage adaptation.
“Adaptation” could be the key theme for this Autumn Statement more generally. The Government and the economy need to adapt to Brexit, adapt to Trump, adapt to new economic realities, adapt to new technologies, and adapt to climate change. Let’s home Hammond has the imagination and the flexibility to get us there.