The Autumn Statement and buckets of water

David Willetts, who I have generally found to be pretty sensible, praises Hammond’s Autumn Statement in the FT as casting off Osborne and Treasury orthodoxy. This is the same Autumn Statement that I described as a return of austerity: wasting resources by cutting spending when interest rates are at their lower bound. I think these two different views of the same event can be explained by an analogy.

Imagine four different reactions after a fire breaks out.

1. The house is fitted with a sprinkler system which puts the fire out pretty quickly
   
   
2. There is no sprinkler system, but the house owners find every drop of water they can, using buckets and hoses, to put it out
   
   
3. The owners get one bucket, but only ever fill it half up because water is not free
   
   
4. The owners do nothing: the fire will soon burn it itself out, they say, and water needs to be conserved.
   
   

In case it is not obvious, the fire is a negative output gap - wasting resources - and water is the deficit or debt. David Willetts is praising Hammond for moving from (4) to (3). Instead what he and the Treasury should be doing is (2), and then installing (1), which if you haven’t guessed is analogous to a fiscal rule with a zero lower bound knockout.

I know the Conservatives will not do (1) until this generation of politicians have passed, because it would be an implicit admission that 2010 austerity was a mistake. I also know that Labour is committed to such a fiscal rule.

Hammond may get lucky, and economic growth could be much stronger than forecast such that the MPC soon stops QE and raises rates. In my analogy, the fire might not spread. But policy should always take account of reasonable risks, and the probability at the moment is that we will stay at the lower bound for some time. The official output gap may be small compared to 2010 (although I worry it might in reality be a lot larger), but if you discovered a fire in your house what would you do?

The Autumn Statement marks the return of austerity

One of the problems with instant responses is that you miss the big picture. And although everything I wrote immediately after the Autumn Statement was perfectly correct, I too failed to spell out the big picture. The big picture is that austerity has returned. (Credit to Rick for a much better call.)

Let me explain. Unlike some, I do not just define austerity as fiscal consolidation or government spending cuts. Instead I define it as fiscal consolidation that creates an output gap. That should normally only happen for three reasons:

1. you are part of a monetary union (or fixed rate regime) and the rest of the union is not doing fiscal consolidation (as much).
   
   
2. if interest rates are stuck at their lower bound.
   
   
3. If the monetary authority is incompetent.

I believe it makes sense to define austerity that way, because only then does fiscal consolidation lead to a waste of aggregate resources.

A competent central bankers’ tell (as in poker) for being at the zero lower bound is that they embark on new Quantitative Easing (QE). Central bankers know that interest rates are a much more reliable instrument than QE, so expanding QE tells us we are at the lower bound as they see it. We also know that fiscal expansion is a more reliable instrument than QE. So if central banks are doing QE, it pretty well follows that we have austerity.

Now Hammond could have changed that on Wednesday by announcing a significant fiscal stimulus relative to previous plans. He did not. The increase in public investment, as I said in my previous post and the IFS confirms, was small, as were his other measures. This, as Martin Sandbu points out (who, naturally, also called it right), was a huge missed opportunity. Don’t get misled by actually borrowing levels to judge changes in fiscal stance: most of the additional borrowing was unintentional.

As I have tried to explain on many occasions, the nature of policy pre-Brexit was different from policy in 2010 and 2011. The later was austerity as I like to define it. The former was bad in many ways, one of which was to run the risk of more austerity if we had a negative demand shock. Brexit was a negative demand shock, and so we now have austerity, and Hammond did far too little to rectify his predecessors mistake.

So why did Hammond keep his squeeze on the public sector’s current spending largely unchanged (again, see my previous post for the relevant chart)? Why not give some money to the NHS? Perhaps he too wants to pursue deficit deceit: to shrink the state. Another possible reason is that the Treasury has persuaded him that he should not ‘take any risks’ with public debt. Let me end by saying a bit about that.

Another definition of austerity beside the two already mentioned is an economic policy that focuses above all else on the need to reduce government debt levels. That is the sense of austerity being used in this BBC piece. Needless to say I very much side with Jonathan Portes rather than Michael McMahon on this. But many journalists are puzzled nevertheless: what about all that stuff about the world falling in if debt to GDP reached 90% of GDP? At what level do those who buy UK government debt start to worry about default? I will talk about that tomorrow.

2016 Autumn Statement

Got back from a trip to London to give my lecture (pics above: thanks to everyone at SPERI and New Statesman, plus Beth Rigby for chairing and everyone else for coming) looking forward to not thinking about economics for the rest of the day, only to find the Chancellor had given an Autumn Statement. Luckily the whole thing appears to be a damp squib compared to the expectations raised beforehand, so here are just a few points. On helping the so-called just about managing, see the ever excellent Ben Chu.

Public investment

Remember all the talk beforehand about substantial increases in public investment? What we got is increases of 0.3% or 0.4% of GDP in each of the financial years from 2017 to 2020. These increases give us figures that are slightly above the numbers we saw from the Labour government in the years immediately before the financial crisis. We should be spending much, much more when interest rates are so low.

Fiscal rules

There was also much speculation that we might return to more sensible fiscal rules, now that Osborne’s had been busted. Instead the new Charter for Budget Responsibility is honestly not worth the paper it is written on. We have a target for the total cyclically adjusted deficit (including investment) for a fixed year. Whatever the number involved, this makes two mistakes: having a fixed rather than rolling date, and by including public investment in that target. It is a recipe for panic cuts in public investment a year or two before the target date.

There is also a target of a falling debt to GDP ratio by the same date. I’m at a loss to understand why you need a target for this as well as a target for the deficit. The change in the debt to GDP ratio is after all just the change in debt (which is the deficit) and the change in GDP. So targeting the change in the debt to GDP ratio just adds to the deficit target some things that you cannot control: GDP growth and your position in the business cycle. I knew there would be no zero lower bound knock out, because that would be a clear admission that 2010 austerity was a mistake. But I did hope for something more intelligent than this.

I fear George Osborne has totally discredited the idea of a fiscal rule. Remember that Labour stuck to its fiscal rules for 10 years, before they inevitably fell victim to the largest recession since the 1930s. Yes there was fiddling at the margin, but the important point was that they did have a strong influence on what the Chancellor did. I now suspect that, by breaking a whole series of rules within a shorter period of years, whatever a Conservative Chancellor says has become pretty worthless.

The fuel duty fiddle

There is this great chart in the OBR’s autumn statement document.

It shows how Conservative Chancellors keep postponing rises in fuel duty. One obvious question is why. But the OBR is also concerned about whether this makes a mockery of its forecasts. Each year they are obliged by parliament to continue to assume that in all subsequent years the government will raise fuel duty after each ‘one-off’ cut. And almost each time the Chancellor announces a ‘give away’ for motorists: they will postpone any increase ‘just for this year’. You can see why they do it: it allows the papers to write favourable headlines. But if they really are going to go on doing this, it means that really their policy is to have no increases in fuel duty. Fiscal forecasts based on the assumption that they will increase fuel duty will be much too optimistic. The government is fooling parliament and the public, but the OBR cannot do anything about it because of the restrictive rules it is forced to operate under.

The cost of Brexit

The big news was of course the higher levels of borrowing. As this table shows, a significant part of that is due to the fiscal costs of Brexit.

Surprise surprise - there will actually be less money available for the NHS and other public services after leaving, rather than more. It is as if that red Leave bus just crashed and rolled over so it is now upside down. The two big factors are lower productivity growth and lower immigration. The OBR has, unsurprisingly, followed their own previous analysis (immigration) and the consensus economist view (productivity growth).

I can almost guarantee that the Sun and Mail will make no mention of this - or if they do it will only be to rubbish the OBR. So, following the theme of my lecture, I really hope that the broadcasters’ nightly news programmes pick this up. Channel 4 news did do so, but I didn’t watch the others (let me know in comments).

The NHS and squeezing the public sector

Not a penny more for an NHS in crisis. Make no mistake, as this blog has shown before, the current crisis in the NHS is simply because it has been starved of resources for the last six years. I really wish Labour (it has to be them, because they are the only party who the media will take any notice of) would run a campaign that busted the myth of a ‘protected’ NHS. But what Hammond’s refusal to do anything about this shows is that this government is continuing the squeeze of the public sector begun by the Coalition. Here is the relevant chart from the OBR. 

Five small thoughts on the Autumn Statement

I talked about the big picture here and here, but as ever there is a lot of interesting detail. Here are five thoughts that I have not seen expressed elsewhere.

1) Tax credits. As people gradually began to twig, the U-turn on tax credits is only temporary: most tax credits will become part of Universal Credit when it is introduced, and the cuts there remain. As the Resolution Foundation show, those at the lower end of the income distribution are eventually going to be made a lot worse off.

But it’s still a big victory for those opposed to the tax credit cuts, for two reasons. First, a few years without the cuts are worth having. Second, and perhaps more importantly, Osborne wanted the cuts to come in early so that their memory would be diminished by the time of the next election. That will no longer happen, which might mean that when the time comes they too will be dropped/delayed.

2) Apprenticeship levy. One of the problems economists have with budget/autumn statement commentary is incidence - it is generally assumed that a tax on business is different from a tax on wages. But as the OBR point out, the evidence suggests that higher payroll taxes (‘taxes on jobs’), which this levy essentially is, will be largely met by firms paying lower wages. But if the Chancellor had raised the same amount of money by increasing employees NICs, everyone would be making much more fuss about this tax increase (particularly as he had pledged not to do so).

One point I didn’t hear mentioned is that we used to have an apprenticeship levy - it was abolished by Mrs. Thatcher.

3) Democracy. I’m occasionally told that I’m too critical of this government, and some even suggested on Wednesday that this Autumn Statement represented a move to capture the centre ground. But the Statement included a 19% cut in money provided to opposition parties. The Treasury said it was “time for political parties to pull their weight in difficult times.” I think the chief executive of the Electoral Reform Society was nearer the mark when she said it was “bad news for democracy”.

4) Labour. Talking of opposition, there was a lovely moment at the end of Osborne’s speech where he noted that Labour had suggested maybe a 10% cut in money for police was appropriate, only to announce no cut at all. It was just one more example of how timid Labour has become. Would it have dared increase the stamp duty on second homes/buy to let by so much? And then of course there was the higher minimum wage in July.

I normally try to avoid watching/reading political speeches, and only turned the TV on to see how John McDonnell performed. As I have said before, many on the left are their own worst enemies when it comes to the issue of political spin. They despise it, which is healthy in itself, but they actually need to be far better at it than their opponents because of media bias. Of course some things are so blindingly obvious …

5) Fragile fiscal forecasts. The thing I really dislike about occasions like this is all the emphasis on the aggregate fiscal numbers. Some people seemed surprised that the OBR should make such a big change to its tax take forecast, but as a one time forecaster it did not surprise me a bit. Macro forecasts are very unreliable anyway, and one of the hardest macro numbers to forecast is the budget deficit. Yet people obsess over small changes to the deficit in future years, as if this mattered. It does not.

One final comment on comments. This end of austerity meme is silly. Here is a chart.

Is this the right way to shrink the state (NHS edition)?

In terms of changes since his July budget, the basic story of the Autumn Statement is that George Osborne has used more favourable tax forecasts from the OBR to ease up a little on planned spending cuts. The stress here is on ‘a little’. This is why my piece for The Independent focuses on the big picture. (There are a number of minor points that I think are interesting, and I’ll comment on those in a later post.) We still have sharp fiscal tightening, with the OBR’s estimate of the cyclically adjusted budget deficit showing a turnaround worth 4% of GDP between 2015/16 and 2019/20. (That is nearly as much as the contraction from 2009/10 until 2015/16. The turnaround in the actual deficit is slightly larger.) While the US and Euro area ease off on fiscal consolidation, George wants to carry on.

For regular readers there are two new points that I make in The Independent article. The first is about the myth of ‘protected departments’. It is classic spin: employ words which the media will use endlessly that do not mean what most people think they mean. The second is that if the goal is to reduce the size of the state, this seems a remarkably incompetent way of doing it. Rather than look at what the state does and strategically decide what we could do without, the method seems to be to keep cutting until a crisis becomes visible. I do not think enough is made of this government’s incompetence. I want to illustrate both points by looking at health.

Let’s start with this nice chart from John Appleby of the King’s Fund. It should be shown every time anyone claims that NHS spending under this government has been protected.

For reasons that are well known, the share of spending on health pretty well everywhere has been rising steadily since WWII. Try to reverse that and you get a crisis. Try to reverse that when you are also slashing local authority spending for community help, so that elderly patients cannot be discharged into local authority care, and you get a major crisis.

But that is not the only sign of incompetence. Under the coalition Cameron undertook a massive reorganisation of the NHS, which was badly conceived and used up precious resources. (Perhaps the biggest political failure of the Liberal Democrats in coalition was to allow this reorganisation to go through: see this Institute for Government report aptly titled ‘Never Again?’) Then before the last election the Conservatives thought it would be a clever strategy to establish a ‘7-day a week’ health service. To try and justify that policy, health minister Jeremy Hunt made dodgy use of data to argue that health outcomes were worse if you were admitted to hospital at the weekend. Did no one tell him that this might lead some to do themselves harm by trying to delay going into hospital?

There is no money to fund this new policy, so Hunt has tried to restructure junior doctors contracts to pay for it. With many junior doctors already leaving the UK to work overseas, this was the last straw and they have voted overwhelmingly to go on strike. (Watch this video if you think picking this fight is clever politics.) In 2012 training places for nurses were cut, so now hospitals have to use more expensive agency nurses. All this indicates basic incompetence by those who ultimately are responsible for the NHS.

It was this kind of thing that I had in mind when I wrote: “It is difficult to know which is worse: duplicity to achieve an ideological goal or pursuing that goal incompetently.”

Postscript: More detail on the small print of the spending review settlement from Sally Gainsbury here.