Spring Statement: Don’t Lose Sight of the Improving Public Finances

Today the Chancellor delivered his Spring Statement. While the future plans outlined in the Statement may yet be overshadowed by the political uncertainty over Brexit, the current picture of a solid improvement in the public finances is there for all to see.

This statement will also be followed by two big fiscal events later this year, with the Autumn Budget and the Comprehensive Spending Review that outlines future spending plans for government departments.

A relatively positive economic message

The Chancellor was able to deliver a relatively positive economic message. He highlighted the nine years of unbroken quarterly growth, that the jobs market remains very healthy and this is expected to continue, wages are now starting to rise in excess of inflation and that public finances are improving significantly. Indeed, the recovery in wages should underpin consumption, while the improvement in public finances allows scope to relax spending in coming years.

There is still a disconnect between some data, as the improving tax revenues and a buoyant jobs market might suggest the economy is growing at a faster pace than the GDP figures suggest. Economic growth this year is expected to be modest at 1.2%, and although this represents a downward revision it is largely indicative of a recent global slowdown. Growth is then expected to grow 1.4% next year and 1.6% a year in each of the following three years, according to the independent OBR, who provide the official forecasts.

Yet deep-rooted imbalances remain

The challenge, though, is that it has taken some time to recover from the aftermath of the 2008 financial crisis. Moreover, the economy still has many deep-rooted imbalances, including the need for more regional growth and continued low productivity. Today, Mr Hammond reminded us of his previously announced £37 billion National Productivity Investment Fund for areas such as infrastructure, skills and technology.

In addition to macro imbalances – including a large trade deficit and too low a level of investment – the economy continues to suffer from other imbalances such as those between London and the rest; urban-rural; coastal-inland; home owner-those who rent; skilled-unskilled; and old-young. These will take time to address and would involve a whole array of policy areas.

It is the public finances that merit positive attention. We have been positive about this trend for some time, when the consensus was far more cautious. The combination of steady growth in nominal GDP, alongside low rates and yields, creates a positive backdrop for debt to GDP to fall.

The forecasts for debt to GDP are credible, perhaps too cautious, with debt to GDP expected to fall from 82.2% in 2019/20 to 73.0% by 2023/24. Significantly, and as domestic politics necessitates, more scope is being created for increased domestic spending in the Spending Review later this year.

Spending in many areas is still heavily constrained

The Chancellor unveiled this year’s envelope, which would represent a 1.2% per year real terms increase in departmental spending. This is welcome, but given the large rise of £34 billion announced already in spending for the NHS, this still leaves little scope for other departments.

Therein lies the challenge, as with a rising population, spending per person in many other departmental areas is still heavily constrained. It does reflect an end to austerity, as the 2010 review announced a 3.0% per year real terms cut in public spending over five years, as austerity hit. By 2015, the real terms cut was 1.3% per year.

The likely impact of Brexit remains unknown

The big unanswered question, of course, is the likely impact of Brexit. The Chancellor made clear his plans assume a smooth and orderly exit, with a transition. I agreed with the Chancellor when he said leaving the EU smoothly would result in an immediate “deal dividend”, with uncertainty lifting and investment recovering. Investment plans have suffered in the wake of the 2016 Referendum, being delayed and restraining growth.

The question, though, is what might happen with a no deal. His view was that no deal would cause significant near-term disruption but would also result in fiscal and monetary intervention. This policy reaction makes sense as it is still opaque how much preparation has taken place for no deal.

In terms of government finances there will be scope to spend domestically funds which are currently sent to the EU – but a genuine Brexit dividend would require the economy to perform better outside the EU than it would have done within. This leads into the wider policy debate, including the need to get three areas right: the domestic policy agenda; the future relationship with the EU; and positioning the UK to compete globally.

The Chancellor made clear today that he is assuming a smooth future relationship with the EU, but also the message today was that the improving public finances allow scope for a more proactive future fiscal domestic policy agenda.

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