How well George Osborne convinces the country that things are not quite as bad as they were some 18 months ago depends just how well he answers our questions in a couple of weeks. Back then he preached doom, gloom and austerity to carry through a fierce programme of deficit reduction, with the goal of a balanced budget in 2015. This straightjacket of cuts was quietly relaxed in his pre-budget statement last year, when he said the balance could wait until 2016.
Now, Osborne will move from survival measures intended to retrieve an economy from melt-down to a set designed to stimulate growth; the next stage in an economic re-invigoration. As John Redwood, a former banker, former Treasury secretary and close confidant of the chancellor, says, “It should be a budget for growth, a budget for jobs”. The key to obtaining growth, he adds, is by encouraging business. “The whole strategy is predicated on a private-sector led recovery and the deficit reduction mainly relies upon a big increase in tax revenue, which in turn requires a reasonable rate of growth to deliver the strategy as advertised. He needs to make sure the private sector is growing at a decent pace. It clearly hasn’t been growing very quickly in the last year. It had a small reduction for the last quarter.”
It should be a budget for growth, a budget for jobsJohn Redwood
The financial sector is watching out for growth stimuli says George Magnus, the chief economic adviser to UBS. He says, “The issue is whether the chancellor feels compelled to get the economy to grow a bit faster this year. It won’t be that long before they think about a pre-election run-in. There may be measures to do this.”
The end is NI?
Magnus suggests the chancellor may cut National Insurance charges to companies, or facilitate subsidies or tax breaks for investment or depreciation allowances for companies. He also reckons he may change income tax tables.
“There are all sorts of things government can do,” says Magnus. “It depends on how much leeway Osborne thinks he has in terms of money to spare. He hasn’t got that much, in the strict confines of the fiscal plans laid out at the beginning of the parliament. The issue is whether they can now apply their rules a bit more flexibly, now that they have established their bona fides as reliable budget cutters.”
The need to encourage the private sector to fulfil its role as the country’s engine of growth will be at the forefront of the chancellor’s intentions, says Lord Michael Wills, a former Labour government minister and businessman. “They ought to be looking at ways in which they can encourage genuine enterprise, but these are difficult things to do, and many of them require upfront money. There will be a move to raise income tax thresholds to take more relatively lowly-paid people out of tax, which is a good thing. There probably ought to be a cut in VAT. There ought to be more vigorous attacks on tax evasion. This bit requires more investment and it is very difficult in the current circumstances.”
According to John Philpott, the chief economist at the Chartered Institute for Personnel Development, “it would be sensible for the government to borrow more and invest in activities that will stimulate the economy, but that is not the right thing for it to do at the moment. The Keynesian solution is still there to be used, but it is not being picked up, so we are stuck with what we have got.”
Yet the chancellor has more bows for his quiver than many observers expected at the end of last year. Economists say that the omens for rising GDP have improved, and Steven Lewis, an analyst at Monument Securities, says the chancellor is facing a dilemma. “In this financial year we will come in slightly better than perhaps the Office for Budget Responsibility predicted. He has still to show that he is sticking to Plan A, as he calls it. But he must show that any changes he makes in either direction are simply to keep the economy on track, so that it delivers the results that Plan A is meant to deliver. He might do a bit of tightening up. And at the same time he could allow some flexibility in the future projection for the budget deficits. As long as he has them coming down he can still argue that he is making progress.”
Measure for measure
A number of large measures were laid out in the pre-budget statement that may now be brought into the battle to stimulate growth and job creation, says Magnus. “They could push out further the year by which they want to balance the budget in structural terms. You could change the allocation of public expenditure, to bring forward or switch to more employment generative investment projects. There is a proposal for a Green Bank with £3bn, that isn’t operational. In the November statement, he announced a £40bn programme for credit easing for SMEs and that hasn’t got off the ground. The government has talked about a lot of things and nothing has happened. There is limited room for manoeuvre but the government is not without scope for some shift to give us hope that we can squeeze a little more growth over the next couple of years.”
Even political supporters of the chancellor are now prepared to say that there is scope for adjusting the programme of deficit reduction announced at the start of the Parliament to respond to today’s weak economic growth.
One colleague on the ministerial front bench in the House of Lords says, “We have a sort of ‘warped’ public sector; we have too much current public sector spending, and not enough public sector investment. The chancellor should educate the world about the concept of good deficits and bad deficits. And he should also define how bad deficits can become good deficits.
There needs to be much more focus on the debt rather than on the deficitLord Michael Forsyth
Good is where you borrow the money to put it into real payback in investments. Payback must obviously be defined more broadly than just the commercial sense, because of externalities and social gains through such measures as building better railways so you have less polluted highways. Bad borrowing is chucking endless subsidies in the wrong directions. Big deficits are OK if they are good deficits, that is, if the borrowing is for investments that are recognised as such.”
An expansion in debt is an anathema to former Conservative minister Lord Michael Forsyth, who argues that the public sector is crowding out the private sector. “There needs to be much more focus on the debt rather than on the deficit,” he says. “There must be more focus on how we can create the measures, and the wealth, that we need to pay down that debt. The easiest way to pay down is to create the money with which to pay it off. The mantra now is: We must have low interest rates. But there is a price to be paid for that, regarding savings and investment. We need to focus on why we are spending considerably more than our income, and our debt is growing.”
Deficit remains key issue
The public deficit remains of primary concern to Forsyth, who warns that state borrowing is unsustainably high. “For all the concern expressed about austerity and cuts, we are not actually making much progress in reducing the rate at which our indebtedness is growing. If you have the state spending more than 50% of GDP, you are unlikely to get much in the way of growth. If you are raising marginal rates of tax for political reasons, then you need to recognise that the price that you will pay will be less growth and less revenue. The national debate about the budget deficit reduction issue is highly misleading, because the general public don’t really follow the terminology carefully. It gives them the impression that we are reducing our debt, as opposed to trying to reduce the deficit. Therefore the seriousness of our overall position is not fully recognised. That makes it harder to get consent for the measures that need to be taken.”
Magnus questions the private sector’s capacity to lead the economic growth that is so badly needed. He says, “We aren’t creating aggregate growth in employment and the people who are in work aren’t capable of generating huge increases in income, because the environment is weak, because the companies have this cost-cutting mantra. If you put weak employment and weak income together, you don’t have much economic growth. Although companies have a lot of cash sitting on their balance sheet, they are not motivated to spend it on investment, because the prospects don’t look brilliant. The lack of growth drivers is due to the financial crash, where we relied on housing construction and financial services before 2007. Now they have all gone AWOL and there is nothing left. The underlying tenor is very weak.”
One of the greatest inhibitors to growth is the state of the country’s banks, says Redwood. He says he would like to see the chancellor propose a break-up of Royal Bank of Scotland into a good and bad bank. The good bank, he says, can act as a conduit for the redistribution of funds to the nation’s companies, currently starved of new investment.
Redwood explains, “The economy isn’t going to grow quickly enough unless they sort out the pretty poor state of the clearing bank industry. We don’t have enough banking capital and enough banking competition in the domestic market to power the recovery strongly enough. The government needs to create three working clearing banks out of the assets of RBS and float them off into the private sector and get them to raise substantial capital at the point when they float them off.
“So we then have three well-financed clearing banks, in addition to what we have at the moment. These will then inject quite a lot of money into new projects and good ideas. That might be what we need to get things going again.”
Such a structure is vital to stimulate the current sluggish private sector. “This will ease up credit in a sensible way because clearly we are suffering from the long shadow of the credit crunch. We have broken banks and the regulators demanding banks have more capital. This is spot in line with what Sir John Vickers (in his Independent Banking Commission report) recommended.”
Growth on the way?
Watching the chancellor’s budget statement with particular interest will be the players in the bond markets and the credit ratings agencies, says Lord Wills. They have, so far, looked favourably on the chancellor’s austerity package. But they too are concerned about the lack of growth and will want to see some plan to revive activity. “The bond markets want to see that Britain has a way of growing again,” says Wills. “These things are self-reinforcing, and people risk losing confidence.”
For now, the chancellor can be pleased with himself. The dire warnings of the Coalition’s first budget have not been realised and he has a more positive scenario than was first feared. While the “bond market vigilantes” (in the words of one economist) continue to circle, they see a group of steely politicians who have measures sufficient to fend off a crisis. Magnus says, “It is by no means as sombre a background as it was for the first budget. It is not a crisis backdrop but there is not much for people to look forward to. It is not an emergency, but it is important, because if growth stalls badly or goes into reverse, the chancellor’s fiscal arithmetic comes completely unstuck.”
Growth remains the part of the jigsaw that eludes even this chancellor. This budget will seek to fill that gap in the puzzle.
A panel of members from ICAEW’s Regional Strategy Boards tell us what they would like to see from the budget
“Cut out bureaucracy. Let business get on with business, unfettered by EU legislation”
“Some local authority funding should be ring-fenced at affordable rates for small and micro businesses”
“Bring back the annual investment allowance of £100,000. Having it capped at £25,000 reduces the incentive to invest in capital projects”
“Investing in skills for growth is critical. If the country needs more accountants, scientists and engineers, then let’s encourage businesses to drive this change by giving enhanced tax relief for education sponsorship akin to the R&D scheme. The lost tax revenue would be balanced off by growth these skills would bring in the long-term”
“Increase personal allowances to £10,000. Simplify tax rates.Eliminate the 50% rate of income tax. Introduce a standard 25% rate of corporation tax”
“Considerable waste remains throughout local and central government – efficiency savings, rather than cuts, need to be made”
“Higher rates of personal tax are a disincentive to economic growth. Maintain the stance on spending cuts and encourage growth through investment reliefs and tax reduction”
“Look at how other countries use lower VAT rates to stimulate spending in critical sectors – like tourism and building ”