Rishi Sunak hopes to emulate Gordon Brown but risks resembling Anthony Barber whose policy hastened the Conservatives’ double defeat in 1974.
First published in March 2020.
When their clothes are stolen, oppositions can’t condemn the thief’s dress sense. So Labour’s attack on Rishi Sunak’s first budget has mainly been along the lines that it’s ten years too late. If the Conservatives had been as free-spending then, instead of agonising over the budget deficit and trying to narrow it by shrinking the public sector, we’d have had a larger and stronger economy with which to fend off the stresses of Brexit transition and Covid-19.
But while it’s possible that the UK’s new ‘stimulus plan’ would have been better timed to coincide with Obama’s, the argument that it’s ‘better late than never’ is highly dangerous. Today’s economic situation has changed fundamentally from ten years ago, in a way that works against the massive fiscal and monetary relaxation announced in mid-March.
Lack of slack
This turnaround is captured in the Office for Budget Responsibility (OBR) estimate of the ‘output gap’, the distance between current national output (GDP) and the output we could potentially produce. In 2010 the UK and its major trade partners were in the early stages of recovery from the worst global downturn in demand for 80 years. Actual GDP was at least 2% below potential. With interest rates falling close to zero, this left significant room for a government spending spree to continue the rebound and close the gap. Because of the new government austerity, the recovery flatlined and the output gap stayed close to 2% until the time for pre-election giveaways in 2014.
OBR Output Gap estimates. / OBR Economic and Fiscal Outlook March 2020
Today, according to the OBR, the output gap has closed, as private sector demand picks up (helped by a new rise in consumer borrowing) and old capacity is scrapped due to obsolescence or lack of use. Production since 2016 may actually have been unsustainably high, and liable to be brought down by rising cost pressures. The symptoms of this supply-side stress are in the statistics that the government claims credit for – record-high employment, low unemployment, and faster wage growth as employers compete for new hires.
The OBR estimates do show the output gap dropping back since the Brexit referendum, and it points to private-sector forecasters who still see a lot of slack. But if the OBR is right about the absence of spare capacity, then the government is wrong to assume that its stimulus (from £175bn of new medium-term spending against just £25bn of new tax revenue) will significantly boost future growth rates. These are now set to be lower than those that followed the global crash, and less than half the annual average that preceded it – at just 1.1% this year, 1.8% in 2021, 1.5% in 2022 and 1.3% in 2023. It would take a productivity miracle – after ten years of stagnant output per employee – to improve on these growth rates in the absence of spare capacity.
On top of existing supply-side constraints, the economy is about to be hit by several changes that will further constrain the supply of labour and essential inputs – including Covid-19 disruption of production in China and mainland Europe, the exit from the EU single market and custom union when the transition phase ends in December, new curbs on low-skilled immigration, and rapid scaling-down of carbon-fuelled activity, which locks-in existing bottlenecks such as those at Heathrow.
The Chancellor countered this danger in his Budget speech by pointing to his measures to boost the supply side – including significant investments in new transport links, house-building and research and development (R&D). But these will take years to add new capacity or raise the productivity of existing jobs. In the meantime, they add to demand for new employees that we don’t have, and supplies that have already been swept from the shelves.
The fifty-year switch
Sunak hopes to emulate Gordon Brown in Blair’s second term, when cleverly concealed tax rises had been supplemented by the financial sector’s pre-crisis boom, letting Labour spend freely and still meet its fiscal targets, guaranteeing re-election despite an unpopular Iraq war. But he risks resembling Anthony Barber – the Conservative Chancellor who arrived in 1970, at the end of the long post-war boom, and launched a stop-go rollercoaster that hastened the Conservatives’ double defeat in 1974.
By 1972, Barber’s attempt to balance the budget by matching his tax cuts with a public spending squeeze had only choked off the recovery sparked by Labour’s 1967 devaluation of the pound. So the Conservatives launched a ‘dash for growth’, cutting taxes further while taking the lid off public spending. This coincided with a sharp relaxation of monetary policy, as the ‘Competition and Credit Control’ policy led to a surge in low-cost lending – much as March’s half-point cut in the Bank of England base rate is designed to do. But the ‘Barber Boom’ ran up against the supply-side constraints of full employment, compounded by OPEC’s quadrupling of world oil prices.
Rivals to OPEC have sent oil prices tumbling this year, giving the government one refreshing contrast to the situation fifty years ago. In other respects, the parallels between Boris Johnson and Edward Heath – both newly-arrived, excitingly unorthodox Conservative leaders who were quickly forced to replace their first-choice Chancellors – may turn out to be uncomfortably close.🔷
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