Osborne aka Brown

George Osborne spent much of his early years in Parliament studying Gordon Brown.  The Autumn Spending Review bears many Brownian hallmarks.

First ensure expectations are set low; off-the-record media briefings about the savage cuts that would be required from many departments meant that cuts to the non-protected departments were expected to be about 27% over the life of the Parliament with even the police having to suffer.

Second, use optimistic expectations for the end of the period when, you desperately hope, you will no longer be Chancellor but will be Prime Minister and not seen as responsible for failing to deliver.  In this Osborne has been handed a huge bonus from the Office of Budget Responsibility (OBR) who have, since the summer budget, found him an extra £27bn, based on higher expected tax receipts even though economic growth is not expected to be any greater and lower interest rates on government debt, on the assumption that the BoE keeps rates lower for longer. These assumptions could turn out to be wrong, particularly as they were made before the recent very disappointing public finance data for September which showed much weaker tax revenue than expected.

Third, find several ways to extract more tax from the economy without it creating negative headlines. Parliament has only recently passed legislation preventing the government from raising Income Tax, National Insurance and VAT. There are at least 3 tax increases in this Review. First, the 2% precept that local authorities will be able to charge on top of Council Tax to pay for social care.  The costs of social care are the responsibility of local authorities and the introduction and proposed increases in the National Living Wage mean that these will be a major problem for local authorities, in addition to the rising demand for such services from an ageing population.  Local authorities, rather than the government will take the political flak for this tax increase. Second, there will be a 0.5% Apprenticeship Levy applied to employers payrolls where these exceed £3million, so only the larger companies will pay. Third the increase in stamp duty for second homes and buy-to-let-investors will target those who are clearly well-off.

Finally, in your speech to Parliament, deliver lots of positive surprises to the low expectations you have set so that the news media will appear to be reporting a triumph.  In particular the total withdrawal of the plans to taper tax credits and an increase in spending on the police

This was an Autumn Spending Review that Ed Balls would not have been too unhappy to have given, had he been the Chancellor, albeit he would have run slightly higher deficits one suspects.  If he had it would have been labelled as a ”Tax and Spend” Review – both revenues and spending are about £30bn higher than was expected at the time of the Summer Budget.

There is little impact on UK economic growth and inflation forecasts from the Review, so bond yields and the pound should be little affected.  For some companies with significant labour costs though the Apprenticeship Levy, if the costs cannot be recouped through other cost controls, could be damaging to profits.

As for George Osborne, he will he hoping, in  much the same way that Gordon Brown did that the OBR’s assumptions prove correct, the economy continues to grow, the budget deficit continues to fall, and that he becomes Prime Minister before the next recession appears.

Business Investment: The Key to UK Economic Recovery

Sifting through the small print of the Chancellor’s Autumn Statement, which could be summarised as very much a “steady as she goes” story, one finds the breakdown of the UK economic forecasts generated by the Office of Budget Responsibility. It shows that the sector of the economy which is expected to lead the UK economy back towards growth is Business Investment, which further analysis shows is forecast to grow at a compound annual rate of 9.5% from 2014 to 2017.  Over the same period, Household Consumption is forecast to grow at a compound annual rate of just 2.2%.  Of the four key economic sectors that can drive growth, Household Consumption, Business Investment, Government Spending and Exports, only Business Investment is currently in a position in the UK to lead a recovery.  The Household and Government sectors are both suffering from very high levels of debt and pressure on their incomes and are therefore working hard to curtail spending.  The remaining sector is Exports, but with over half of the UK’s exports going to the rest of the Europe, which is expected to fall back into recession in 2013, export-led growth for the UK economy looks a very distant prospect.

The Chancellor announced two new surprise measures in the Autumn Statement to encourage businesses to invest. The first was to cut the rate of Corporation Tax by another 1% to 21% from 2014, leaving it well below the rates set by other western nations, and a tenfold increase in the tax relief granted on investment by small businesses for 2013 and 2014.  This government has consistently sought to reduce the rate of Corporation Tax since it came to power as an incentive for businesses to invest, grow and create employment in the UK.

Though the growth rates have been quite low at 2.9% and 3.8% for 2011 and 2012 respectively, which have not been sufficient to get the economy as a whole moving strongly, Business Investment has in fact been the fastest-growing part of the UK economy.  Businesses themselves cite two factors when asked why they are not investing more.  One is the readiness of the UK banking system to provide loans to finance investment and the other is a lack of confidence in the economic outlook and hence the generation of a sufficient return on any investment. The Chancellor and the Bank of England have worked together to create the recently-launched “Funding for Lending“ scheme, which provides cheap liquidity for banks who will actually use that liquidity for new loans.  In the first two months of the scheme, only £500m has so far been lent out of a possible £80bn, which is disappointing. If this does not improve soon, then the only explanation left for slow investment growth is a lack of confidence from businesses in the outlook for demand.

Most entrepreneurs are natural optimists, always believing and seeking to do more business and make more profit.  In long periods of little or no growth, such as that which is being currently endured, then such optimism can get squashed by consistent economic disappointment. Normally, the dynamics of capitalism mean that in the downturn, loss-making or unsuccessful businesses withdraw from the market.  This shrinks the supply in that industry, so enabling their more efficient competitors to boost their market share and become more profitable.  However, the recent revelation that 1 in 10 UK businesses are zombie companies, which are effectively bankrupt but are being kept alive by ultra-low interest rates and the reluctance of the banks to admit to more bad debts, is disturbing.  This indicates that this normal operation of the free market system in economic downturns is not currently occurring, leaving less scope for more efficient companies to take the opportunities for them to grow.

There are only two strategies that the UK Government can follow to generate growth.  The first is for the Government to use its strong creditworthiness to borrow in the markets and spend the money productively by, for example, building houses and necessary infrastructure projects.  However, if the money were to be spent less productively, it would merely raise the level of public debt that future generations will need to repay.  The second strategy, which is this government’s preference, is to give the private sector every reason to want to invest, and lead the economy back to growth.  To create the required optimism amongst businesses, it would, paradoxically, help if more companies were made to go out of business.  The costs of this though are more jobs lost and more losses for the banks in the short term, before the opportunities for the survivors can improve.

UK austerity and the UK economic miracle – some surprising data

The official data produced by the independent UK Office for Budget Responsibility supporting the recent Budget, showed up a surprising fact about UK government spending. The major focus of the Coalition Government since it came to power in 2010 has been the control of government spending and consequent reduction in the budget deficit from the £170bn (and 11% of GDP) it inherited from the previous government. Yet the official data show that in each of the two fiscal years that this government has been in office, current government spending has risen in real terms, that is to say after inflation has been accounted for, and that in a two year period when inflation has been permanently above the Bank of England’s 2% target due mainly to the increases in VAT, which are part of the deficit reduction strategy.

It could thus be argued that in the UK, austerity has not yet even begun. That would not be entirely fair, since the measure of current government expenditure excludes capital or investment spending by government. Investment projects are possibly the easier areas of government spending to cut quickly, and there have been large real reductions in non-current government spending. Further, some parts of current spending were permitted to grow in real terms – these were health spending and overseas aid. In addition the automatic economic stabilisers of rising welfare entitlements and rising interest costs on the national debt, have meant that economic weakness tends to boost current government expenditure. Most areas of government spending have seen austerity cuts (with many more to come over the next few years), but for real government spending as a whole, there has been no reduction.

In fact history suggests that such a goal is very difficult to achieve. Mrs Thatcher’s government from 1979 to 1990 did not manage to reduce real government spending, and since then it has risen every year. In nominal (actual cash) terms UK government spending has never fallen year-on-year since 1945..

For the government, the plans for current spending reductions in the next few years imply that the really hard (and unpopular) work only starts now. This may well affect their poll ratings significantly for the next year or two without a clear improvement in economic growth. For the Opposition Labour Party, their claim that the government has been cutting too far and too fast, and that a slower pace of cuts would be more effective do not stand up to any scrutiny as real government spending has not yet even started to fall.

 

 

HSBC compiled some fascinating data for economic growth amongst the major Western economies for the first decade of this century.

2001-2010 average annual % growth rate               Overall                              Per Capita

Japan                                                                                                0.8                                       1.6

UK                                                                                                      1.5                                         1.2

Germany                                                                                           0.8                                        0.8

US                                                                                                       1.6                                         0.7

France                                                                                                1.2                                         0.6

 

There are several surprises here, first Japan’s “lost” decade, the subject of many lectures from Americans and Europeans, is actually a demographic issue. Per capita growth in Japan was double that of the US and Germany and France – Japan has for some time been very aware of its ageing issues and has invested heavily in automation and robotics in order to boost its productivity. Secondly the strength of the US economy is also mostly about demographics – in this case both a younger population than the other countries, arguably reflecting a greater openness to immigration.  Finally the strong performance in both columns of the UK economy – a recent paper from Corry, Valero and Van Reenen confirms this strong  performance and attributes it to service sector productivity factors such as technology and regulation (though NOT banking regulation!). Perhaps history will judge Gordon Brown’s stewardship of the UK economy in this decade more favourably than current commentators.