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Budget 2014

This year’s budget did not do much for the macroeconomic outlook. In that sense, it was in line with expectations. The big picture remains in place – years of spending cuts while hoping economic recovery is sustainable. The chancellor chose to ignore the underlying problems facing the UK economy.
George Osborne’s spin on the economy has been blatant, and often effective. By constantly blaming Labour for the financial crisis and consequent damage to the public finances, he forces Labour spokespeople to either implicitly agree with his assessment or tackle the argument head-on and debate the past, risking sounding irrelevant while most people worry about the future. The latter course of action should have been taken more vigorously, three or four years ago, and the argument about how we got here dealt with. That this did not happen to a sufficient extent has made it more difficult to respond to the conventional wisdom about the recovery and the need for spending cuts. It has also made it more difficult to hold the chancellor to account for missing his borrowing targets and being unclear about how some spending commitments will be permanently funded. Yet hold him to account we must.
The UK economy has continued to recover after a pick-up in activity last summer. Most sectors of the economy are reporting growth, and this is true of manufacturing as well as service sectors. Moreover, many employers are reporting that they are close to operating at full capacity and that they are beginning to find it difficult to recruit. That might seem odd given that the unemployment rate is still above seven per cent, but as employers have recruited so more people have entered the labour market and also public sector workers have found employment in the private sector.
This issue about what spare capacity exists in the economy goes to the heart of economic policy in the UK. If the gap between current and potential GDP is large, then the task of permanently repairing the public finances is easier than if the gap is small, because a small output gap implies more annual government borrowing is unsustainable. Linked to this is the outlook for productivity. The big surprise (still) has been that productivity (output per worker or per hour) has remained stubbornly low rather than rebounded as in previous recoveries. The financial crisis, which began in the United States, plunged the whole economy into recession, and productivity fell too. No one knows why it has not recovered and the Office for Budget Responsibility and others have concluded the UK has suffered a permanent and significant loss of output (and productive potential). If that is true, this government must take its share of much of the blame. Productivity did begin to recover but fell again in 2012. Businesses were struggling to obtain finance and were too worried about the future to increase investment. Yet this Tory-led government reversed policy at just the wrong time. That is one reason why borrowing next year is predicted to be almost double the figure predicted by George Osborne in his first budget in June 2010.
At this point, we should note that GDP statistics are subject to revision, so it is certainly possible that in a few years’ time we will find that productivity was higher than we thought. Still, low productivity does provide an explanation for the growth in employment and also for low wage growth. The ultimate, long-term, answer to the cost of living crisis can be found in a widening of opportunities, for example in education, and higher productivity. Here, the budget was again lacking, with little new news on investment spending and certainly nothing on the scale required. And that really is the issue – with less than half the spending cuts planned having taken place, with income and wealth inequality rising, and with the economy having underperformed for so long, are we prepared to have policies that meet the scale of the long-term challenge before us?

This article was first published by Progress on 21 March 2014.
Progress, 21 March 2014, 22/03/2014

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The Bank of England has raised interest rates, but that does not mean it has been most effectively managing inflation risks.
The Bank should signal it will act if higher prices look likely to translate to higher inflation rate.
The IMF's Fiscal Monitor is actually quite radical.
Spare a thought for finance ministers, and the opposition counterparts who aspire to replace them. The conventional wisdom was that they should at least make an attempt to follow fiscal rules. Now, there are no rules.
My letter in the Financial Times on the need for a framework for economic policy decision-making.
Responding to Brian Griffiths' article in The Article on the risks of inflation.