George Osborne cannot possibly know how long austerity will last

The Chancellor's strategy is based on faulty rules and unproven assumptions about the deficit.

Next week George Osborne will hold forth on the size of the underlying deficit and reveal whether austerity will now extend until at least 2018. When he does, he won’t know what he’s talking about – and he’ll be in good company.  Neither will Ed Balls when he responds, nor will the phalanx of city economists who rush to comment, nor indeed will establishment economic institutions such as the IMF and the OECD.

This isn’t because our current crop of politicians and economists are unusually uninformed. Rather it reflects the fact the debate on fiscal policy is being driven in no small part by an economic concept – the structural deficit - that is very close to being unmeasurable. It’s an example of how what sounds like a sensible idea in theory can go wrong in practice.  

The structural deficit is that bit of the deficit that would still exist even if the economy was running at full capacity: the part that can’t be explained away by the fact that the economy is under-performing.  Giving it consideration is sensible and important. Few would disagree that running a deficit when the economy is stuttering along far below its peak capacity is a very different matter to running one when the economy is booming. The trouble arises, however, when we pretend we can decipher exactly how much of a deficit is cyclical and how much is structural.

Estimating the size of the structural deficit is, to put it mildly, something that sensible people can come to sharply different views on. Last week the Social Market Foundation  think-tank (led by former Treasury official Ian Mulheirn who is no fiscal virgin) published a neat bit of work replicating the methodology used by the Office for Budget Responsibility (OBR) to estimate the gap between the economy’s current output and its full potential. They conclude the output gap is pretty modest: under 2%.  If correct, it’s bad news for our economy, as we’ve had a bigger permanent loss in productive capacity than many realise. And it’s bad news for austerity: the return to growth won’t fill the fiscal gap - further painful changes will be needed to meet the objective of eliminating the structural deficit over five years. The SMF estimate that massive extra spending cuts or tax-rises of around £22bn (over and above all of those already planned) would be needed by 2017/18.

Or maybe they won’t be.  Another plausible report – this time by the respected Capital Economics – tells a very different story. It estimates that our flatling economy might be running as much as 6% below its full potential. If that’s the case the structural deficit is far smaller than we are being led to believe – and Osborne may be planning to tighten fiscal policy by too much, way too much – to the tune of around £35bn - in order to meet his own rule.

So that’s all clear then.

In addition to recognising the confusion over the size of the structural deficit it is worth asking whether setting a target that no-one can agree on is likely to result in further economic damage? You’d think so. But the answer depends on whether you believe that the chancellor’s target on eliminating the structural deficit is going to drive new spending and tax decisions that wouldn’t otherwise have been taken.

This question arises because the target is formulated in a way that means, as Jonathan Portes, Director of the National Institute for Economic and Social Research, has highlighted, it never actually bites. Because it is set on a rolling timetable all the chancellor ever needs to do is demonstrate he plans to get rid of the structural deficit five years from a given point in time. He doesn’t actually need to achieve these plans. Each year the date at which the target will be met can just be pushed back by another twelve months (as happened in last year’s autumn statement). Promises rather than delivery will suffice.

Now, a target without a fixed date is clearly a flexible thing. But I doubt this makes it irrelevant to real decisions.  Politics and the chancellor’s craving for ‘credibility’ are likely to result in the target affecting the cuts Osborne actually makes in the here and now.  He won’t want his target to become a joke – the mañana target. Say, for instance, Osborne announces next Wednesday that an extra £15bn of consolidation is needed in 2017/18 - will that really have no impact on the real choices made about the next few years? He may well believe it is vital that he demonstrates additional fiscal resolve –by implementing extra cuts, not just making more promises.  

But in deciding on the timing of any new cuts Osborne faces contradictory pressures. On the one hand, he may well want to bolster credibility as well as build up the size of spending reductions by acting quickly, for instance freezing spending now on aspects of welfare in order that savings accumulate over the forthcoming years.

Alternatively, there are strong arguments for thinking he’d want to push cuts down the road (as his target allows him to do). Most obviously this is because the economy is currently so weak only a fool would contemplate further undermining it.  But there is another subtler reason for playing it long. If the chancellor has a hunch that the true output gap is actually larger than the OBR currently believes he may want to defer cuts – particularly those cuts that he doesn’t actually want to make – in the hope that over the next few years the OBR revises its view. If this hunch turned out to be correct, then at some point the OBR would end up announcing that the output gap is larger (and the structural deficit smaller) than they previously thought.

The result? A return to growth would solve more of our fiscal problems than we currently expect and Osborne (or indeed Balls) would be in the happy position of being able to scale back some of the cuts that have been pencilled in.  Of course, things could turn out worse rather than better than current OBR assumptions. No-one knows. But in an uncertain world one thing is clear: the current target on the structural deficit magnifies rather than minimises the confusion.      

Nor should we forget that the structural deficit isn’t the only fiscal rule in a spot of trouble. The chancellor’s second target – the commitment to reduce debt as a share of GDP by 2015 - is likely to be breached next week (unless a Treasury accounting fiddle is used to avert this). Either way, the rule is highly arbitrary. If the debt to GDP ratio falls marginally in 2015 but grows thereafter then the rule would have been met but the public finances wouldn’t be sustainable.    

Osborne’s fiscal regime is in a state of disrepair.  The finest minds in the Treasury are currently chasing two faulty fiscal lodestars: a deficit rule which is impossible to accurately measure, resulting in starkly different estimates with very different implications for policy and politics; and a debt rule which is highly arbitrary and tells us very little about the nation’s longer term fiscal health.     

All of which would lead you to think that there would be a major debate – not least on the centre-left - about alternatives to Osborne’s rules. After all, fiscal policy is the issue of our times and will define the next Parliament as much as it has this one. To be fair there are indeed those setting out new and interesting thoughts on the type of framework that might better ensure fiscal sustainability whilst taking account of the strength of the economy  and without falling foul of either false precision or arbitrariness. For now this conversation is only happening at the margins. In the meantime we are stuck with fiscal rules that aren’t fit for purpose. That’s likely to remain the case regardless of what George Osborne says in the Autumn Statement.

Chancellor of the Exchequer George Osborne. Source: Getty

Gavin Kelly is a former adviser to Downing Street and the Treasury. He tweets @GavinJKelly1.

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After a year of chaos, MPs from all parties are trying to stop an extreme Brexit

The Greens are calling for a cross-party commission on Brexit.

One year ago today, I stood on Westminster Bridge as the sun rose over a changed country. By a narrow margin, on an unexpectedly high turnout, a majority of people in Britain had chosen to leave the EU. It wasn’t easy for those of us on the losing side – especially after such scaremongering from the leaders of the Leave campaign – but 23 June 2016 showed the power of a voting opportunity where every vote counted.

A year on from the vote, and the process is in chaos. Perhaps we shouldn’t be surprised. The Leave campaign deliberately never spelled out any detailed plan for Brexit, and senior figures fought internal battles over which model they preferred. One minute Britain would be like Norway, then we’d be like Canada – and then we’d be unique. After the vote Theresa May promised us a "Red, White and Blue Brexit" – and then her ministers kept threatening the EU with walking away with no deal at all which, in fairness, would be unique(ly) reckless. 

We now have our future being negotiated by a government who have just had their majority wiped out. More than half of voters opted for progressive parties at the last election – yet the people representing us in Brussels are the right-wing hardliners David Davis, Liam Fox and Boris Johnson.

Despite widespread opposition, the government has steadfastly refused to unilaterally guarantee EU citizens their rights. This week it has shown its disregard for the environment as it published a Queen’s Speech with no specific plans for environmental protection in the Brexit process either. 

Amid such chaos there is, however, a glimmer of hope. MPs from all parties are working together to stop an extreme Brexit. Labour’s position seems to be softening, and it looks likely that the Scottish Parliament will have a say on the final deal too. The Democratic Unionist Party is regressive in many ways, but there’s a good chance that the government relying on it will soften Brexit for Northern Ireland, at least because of the DUP's insistence on keeping the border with Ireland open. My amendments to the Queen’s speech to give full rights to EU nationals and create an Environmental Protection Act have cross-party support.

With such political instability here at home – and a growing sense among the public that people deserve a final say on any deal - it seems that everything is up for grabs. The government has no mandate for pushing ahead with an extreme Brexit. As the democratic reformers Unlock Democracy said in a recent report “The failure of any party to gain a majority in the recent election has made the need for an inclusive, consensus based working even more imperative.” The referendum should have been the start of a democratic process, not the end of one.

That’s why Greens are calling for a cross-party commission on Brexit, in order to ensure that voices from across the political spectrum are heard in the process. And it’s why we continue to push for a ratification referendum on the final deal negotiated by the government - we want the whole country to have the last word on this, not just the 650 MPs elected to the Parliament via an extremely unrepresentative electoral system.

No one predicted what would happen over the last year. From the referendum, to Theresa May’s disastrous leadership and a progressive majority at a general election. And no one knows exactly what will happen next. But what’s clear is that people across this country should be at the centre of the coming debate over our future – it can’t be stitched up behind closed doors by ministers without a mandate.

Caroline Lucas is the MP for Brighton Pavilion.

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