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EU: Budget Report

My Lords, as the noble Lord, Lord Newby, made clear, the Government are required by the European Communities (Amendment) Act 1993 to submit an assessment of the UK’s convergence programme towards the economic structure of the eurozone. This requirement is perhaps more apt this year than in past years. On the broadest economic assessment, the Government’s convergence programme has been a great success: the eurozone is stagnant and so is the UK. Despite the welcome announcement of some growth in the past quarter, overall performance for the past six months has been growth of nil, and output is still 2.6% below the 1998 peak. Things have come to a pretty pass when growth of 0.6% per year is a cause for celebration. The Chancellor’s statement that this demonstrates that the UK is healing is surely delusional.

Moreover, the second Motion before us commends the Government’s economic stance to the European Union member states, declaring that they should,

“continue on the path of growth-friendly fiscal consolidation”—

I repeat: growth-friendly fiscal consolidation—in the week in which, as a result of UK-style austerity policies being implemented in the eurozone, even German industrial growth has shuddered to a halt. We know that the eurozone is stagnant and that the outcome of the Government’s policies has been to condemn Britain to the same fate. We have, indeed, converged. Therefore, the fundamental question raised by the Budget report and the OBR’s economic and fiscal outlook is whether growth-friendly fiscal consolidation is an economic oxymoron. Will the austerity policies advocated so consistently by this Government result in persistent stagnation, or will they restore the sustained economic growth of over 2% a year that this country desperately needs?

A casual reading of the OBR outlook would suggest that growth will be restored. After all, on page 8, it is argued:

“We expect the economy to grow by 2.3 per cent in 2015, 2.7 per cent in 2016 and 2.8 per cent in 2017”.

That all sounds pretty good, but a more careful reading of the report reveals a disturbing aspect of these predictions. On page 39, the OBR states:

“Our forecasts for medium-term growth are shaped by our estimate of the amount of spare capacity in the economy, and the speed with which it seems likely to be absorbed”.

It then lets the cat out of the bag by stating that,

“the output gap is assumed to narrow at a relatively gradual rate over the medium term”—

I repeat: assumed. In other words, the OBR has no causal explanation of the determination of the growth rates predicted in the medium term. It is merely assumed that by some unspecified mechanism the economy will return to a medium-term growth path when things get back to normal.

Once we realise that this future growth is assumed to happen, the OBR’s forecast for the future path of government borrowing is cast in an entirely new light. The fall in the deficit that is predicted from 2014 onwards is, the OBR makes clear, a function of the assumed increase in revenues consequent upon the assumed reappearance of economic growth. It is revenues that do all the heavy lifting, but those revenues are predicated on the assumption that the economy will return to medium-term growth. It is just an assumption; there is no evidence, no theory or causal explanation.

Once these characteristics of the OBR’s methodology are taken on board, a fundamental question mark is raised over the foundations of the Government’s economic policy, which is set out with admirable clarity on page 1 of the Budget report. They are:

“fiscal responsibility to deal with our debts with a credible deficit reduction plan … monetary activism to support demand … and … supply-side reform to help businesses create jobs”.

Those are the three components of what might be called the austerity strategy. Fundamental questions that are raised from this outline are: does fiscal consolidation cut the deficit, or does it simply cut growth, with little or no impact on the deficit? Is monetary activism an effective means of supporting demand? Are the Government implementing the supply-side reforms that will deliver lasting prosperity? I will deal with these questions in turn.

Noon

First of all, does austerity cut the deficit? The evidence from the UK and from around the world suggests that the answer is: barely at all. Let us examine the evidence in these two documents. The Government boast that,

“the de?cit as a share of GDP is forecast to fall by a third over the three years from 2009-10”.

What they fail to point out is that in 2010, when they took office, the economy was growing by over 2% a year. No wonder the deficit fell. With that growth rate and the tax changes introduced in the Labour Budget of 2010 and the coalition Budget a few months later, it is not surprising that revenues rose sharply. However, with the destruction of business confidence brought about by the Government’s foolish rhetoric of 2010-11 —those silly references to Britain being in the same position as Greece, and the oft repeated but entirely false assertion that high levels of government debt inevitably lead to economic collapse—growth ground to a halt, and so did deficit reduction.

On Tuesday there was an audible sigh of relief from No. 11 Downing Street that borrowing in 2012-13 had apparently fallen by £300 million from £120.9 billion in the previous year. However, in its outlook document, the OBR lets yet another cat out of the bag. If we turn to page 129, we read:

“at least £1.6 billion of the further shortfall in departments’ February forecasts”—

forecasts of spending—

“is the direct result of the Government’s actions to reduce spending in 2012-13 by pushing money forward into future years”.

There it is; they have been fiddling the figures by changing the timing of spending in order to pretend that the deficit has been cut. If we add the £1.6 billion fiddle back into the figures for 2012-13, the deficit has not come down by £300 million; it has gone up by £1.3 billion. The conclusion is clear: cutting the deficit depends on growth; austerity depresses growth and hence fails to deliver significant cuts in the deficit.

Let us turn to the second plank of the Government’s policy:

“monetary activism to support demand”.

There has certainly been plenty of monetary activism: quantitative easing, Project Merlin, Funding for Lending, and now more Funding for Lending. Yet despite scheme after scheme, net lending to business has fallen month by month. In the past three months alone, net lending to business is down by £4.8 billion.

A moment’s thought will reveal why these policies are failing to deliver the goods. With the economy stagnating and the Government committed to yet more austerity, business confidence in the growth of future demand is desperately low. Therefore, even if finance is cheap and readily available, the risks of investments failing to pay off are dauntlingly high. Businessmen will not take the risk of borrowing and losing their shirts, and the banks cannot find enough relatively risk-free projects to lend to. In the words of the famous aphorism, “You can’t push on a string”. What risk is being taken is being taken by households as Funding for Lending flows into the mortgage market.

Again, the conclusion is clear: in the face of fiscal austerity, so-called monetary activism will have only a very limited effect on the growth of demand, and most of that will come from piling risks on the household sector. This does not bode well for the future.

Let us turn to the third plank of the Government’s programme: supply side reform. This is referred to on page 16 of the Budget report as,

“an ambitious housing package and programme of infrastructure investment”.

The Government are quite right to identify the revival of the construction of new housing, in a country with a desperate housing shortage, as an important component of an economic recovery strategy. That is why this morning’s figures showing a further substantial contraction of the construction industry are so worrying. This makes it all the more puzzling that the main government stimulus planned for the housing market—the mortgage guarantee scheme—is targeted not at new build but at the market as a whole, adding to the twist of the housing price spiral already provided by Funding for Lending. This is folly on a grand scale. The reason why young people cannot find affordable accommodation is that not enough homes are being built, and the flow of government funding into the mortgage market will only push house prices further out of their reach.

The Government are also right to focus on infrastructure investment. However, a well known characteristic of infrastructure investment is that it takes time to get going, so why on earth is the £3 billion a year increase in infrastructure spending announced in the Budget postponed for two years? Why do we have to wait? Why do the Government not get on with it now?

To sum up, these documents reveal in stark detail an economic strategy that has failed, is failing and bears no prospect of success in the future. The propositions on which the Government’s policy is based are now widely accepted, not least by the IMF, to be false. Austerity does not beget growth. In the face of austerity, monetary activism does little to support demand, other than by piling greater risk on a household sector that is already, as the European Union report shows, overleveraged. Supply side reform will bear fruit only if this is incentivised by the prospect of growing future demand to take advantage of any beneficial changes. That is why there is a need for a substantial increase in infrastructure spending now; that is why there is a need for monetary activism and government funding guarantees to be focused on investment and new construction; and that is why expanding investment in the skills and technology of the future should be a national priority.

Productivity-focused public investment is vital not only to expand demand but because in the OBR outlook there is another serious warning about storms ahead that has been little noticed—although, to its credit, it was picked up by the EU alert mechanism study. On pages 63 and 64 of the document, the OBR charts deteriorating export performance, notably driven by Britain’s falling share of export markets: in other words, by Britain’s failing competitiveness. This worrying trend has not been offset by the sharp devaluation of the pound that has recently been experienced. The fact

that devaluation has not reversed the trend suggests that the problem is not that Britain’s exports are not cheap; it is that they are not competitive in quality, design and cutting-edge performance. Of course, there are some important exceptions to this dismal picture, but they are far too few.

We need a new strategy for a competitive Britain, and that can be based only on investment. Austerity is the enemy of investment. The way out of the hole that the Government have dug can be led only by a Government with an entirely new approach that halts Britain’s convergence towards a stagnant eurozone.