Labour's bold offer on the deficit question
The next government will face immense challenges. The economy is still recovering from the financial crisis and resulting recession. Many people have seen their living standards fall for years and productivity is only recovering slowly. An ageing population, the threat of climate change, and the opportunities and threats arising from new technology will all be influencing the future shape and direction of our economy. Yet the government will need to improve the condition of the public finances and reduce borrowing to have the ability to meet these challenges on the scale required. In a speech today, Ed Miliband stressed Labour’s commitment to reduce borrowing. It was an important move in the battle between the parties for economic credibility.
Much of the debate about government borrowing takes place in a virtual world, with occasional references to reality. Even the government’s primary fiscal target, to eliminate the structural current deficit in the next five years, is not actually grounded in fact. The target is not for something to actually happen, but for the Office for Budget Responsibility to forecast that it will happen, since the target always looks ahead. The government in practice has missed this target, as set in 2010, but that seems not to matter since the OBR continues to predict it will meet it in future. The Treasury in the latter period of the last Labour government was criticised for extending its forecast of the economic cycle, such that the commitment to balance the budget extended further into the future. Similarly, George Osborne’s target always looks ahead.
Moreover, the OBR’s forecasts are subject to a high degree of uncertainty, leading us further into the virtual world of the deficit debate. For example, the annual borrowing Osborne is targeting is predicted to rise this financial year. That is because the OBR has concluded that lower income tax revenues signal a permanent change in the economy, which means we are nearer full capacity than it thought. Ed Miliband highlighted this link between a low pay economy and stubborn deficits. It means less annual government borrowing will be eroded by economic growth. What is left is called the structural deficit and it is now estimated to be higher. However, this is a guess – it could be higher still. George Osborne was also rescued by the OBR changing its forecast of the interest the government will have to pay on new debt – currently over £90bn a year is added to total government debt, which is over £1.4 trillion. The underlying changes the OBR made amount to almost £18bn a year off borrowing by 2018-19.
Something has changed however. Now, political parties are promising to cut deficits by particular dates in the next parliament, irrespective of the economic circumstances. This is bold stuff indeed. The Conservatives say they will produce a surplus on the overall budget, which includes both current spending and capital investment spending, by 2018-19. Labour says it will eliminate the current budget deficit by the end of the next parliament the 2019-20 financial year if not before, but it will allow borrowing for capital spending. This is more sensible target and compared to the Conservative’s plan amounts to an extra £50bn of borrowing a year by the end of the parliament. However, it is still very challenging. And there is some ambiguity about capital spending since Labour has today repeated its conference pledge to avoid funding new pledges with extra borrowing. Does this apply to investment, which will increase growth? Government investment is forecast to decline as a proportion of GDP under the coalition’s plans.
Ed Miliband made some important points in his speech. He made clear that ‘a successful deficit reduction strategy depends upon reforms of our economy.’ Radical measures are required if the UK economy is to break free from the prospect of years of economic malaise. Ultimately we need to boost productivity and growth. Labour’s commitment to reinventing government as it cuts spending is vital too. The zero based spending review has the potential to transform the way government works, and in a good way, even though difficult decisions will need to be made. Finally, the commitment to sharing the burden of deficit reduction fairly is essential given the inequality we see today. For this pledge to be effective, it must be combined with a message on the economy which shows how we will support people aspiring for a better life for themselves and their families.
This article was first published by Progress on 11 December 2014.