Needing to perform a fiscal twist in a confined space, it looks like Philip Hammond has borrowed some dance steps from former shadow chancellor Ed Balls. Despite some mockery of his recent turns on TV show Strictly Come Dancing, Balls’ footprints are clearly visible on the spending boost the chancellor unveiled in his first Autumn Statement.
Balls regularly castigated the 2010-15 coalition government for being too hasty to cut public spending and raise VAT. He called, in particular, for a boost to infrastructure, skills and housing investment on the basis that without it, a stifled economic recovery would delay the return to budget balance.
Six years on, Hammond has taken much the same stance. Attempts to achieve a budget surplus have been pushed elusively forward to “the next parliament”. Meanwhile, the focus shifts to boosting growth, following a forecast downgrade by the Office for Budget Responsibility, with adverse implications for tax revenues.
To protect against another slowdown, additional spending on public infrastructure (especially housing, roads and telecoms) has been announced. Meanwhile, he is also slipping in some tax reductions – including a return to the 50p top rate and a reduction of taxes on in-work benefits – in case the Supreme Court’s Brexit verdict forces an early election.
Big infrastructure projects are a favoured way to kickstart stalling economies because they can quickly create jobs in areas that most need them. They also generate income that mostly gets spent, boosting other activity. Such projects can pay for themselves through extra tax revenues which then shrink the budget deficit in relation to GDP. Hammond’s quickstep addition is an annual £2 billion boost to research and development, aimed at making those already in work more productive.
George Osborne did something similar. Following the failure of austerity and a dip back into recession in 2011-12, he quietly reinstated several of the initially-suspended infrastructure programmes. Hammond has signalled an intention to go much further with an extra £23 billion to be channelled in the first five years with his new investment fund. His hope is to reverse the impending slowdown and Brexit aftershocks.
It’s not the first time that a party committed to cautious and balanced fiscal policy has veered towards plans it once mocked as ill-timed and irresponsible. A Keynesian-style stimulus – running a deficit to spur growth, and so raising national debt – has historically been easier for Conservative than Labour governments in the UK, and for Republican than Democratic presidencies in the US.
This is because conservatives normally push for lower taxes, based on the belief that tax reductions will actually close a budget deficit by boosting people’s ability and willingness to pay taxes. This wilts under economic analysis. And when reality bites, a switch is made from taxing less to spending more on structures that can constitute a public asset as “security” for the additional public debt.
Labour broke the deficit-boosting record in 2008-10 – but only after the unprecedented bailing-out of a collapsed financial sector. It had previously reduced the public debt, by moving the budget into surplus earlier in its term. Yet the Conservatives, with Hammond now as chancellor, have used the idea of Labour’s “fiscal irresponsibility” to justify huge public spending cuts.
While the deficit has steadily narrowed since 2010, Osborne’s missed targets have meant the Conservative-led governments have added more to public debt than the Labour administration they replaced. Indeed, Labour governments – often elected after a boom has collapsed, and never trusted to borrow as much – have run consistently tighter budgets than those who accuse them of reckless spending.
Hammond’s new investment fund looks very much like the long-term investment bank that Labour has long dreamed of, and never succeeded in, launching.
The Conservatives argue that they can now afford some fiscal relaxation, having earned “credibility” through Osborne’s years of austerity. By drumming home the idea that they will shrink public spending to the smallest fraction of GDP since the 1930s and continuing to lambast Labour for leaving such a large deficit, they manage to deflect criticism. Yet the OBR has confirmed that weaker GDP growth and tax receipts left the 2015-16 deficit at £76 billion, four times its £18 billion forecast.
Is the timing right?
Chancellor Hammond can also argue that historically low interest rates on public debt make this the right time for governments to borrow more. In a world seemingly awash with capital and large corporations sitting on mountains of cash, tax cuts haven’t delivered the needed boost to enterprise, so the state must take a more direct hand.
But the six-year gap between Balls’ and Hammond’s plans may also present problems for the Treasury. With more inflation on the horizon and the UK’s credit rating heading downwards, the government’s phase of virtually costless long-term borrowing is coming to an end. Even yields on long-term bonds are rising, despite the Bank of England halving its base rate to 0.25% immediately after the June 23 referendum.
While big projects may cost more to finance under Hammond than if Osborne had launched them earlier, their growth-reviving benefits may also turn out to be smaller. The multiplier effect of deficit spending on national income is highest when labour markets and consumer spending are slackest, as they were in the UK in 2011-12.
Today, although the economy hasn’t grown enough to close the deficit, most of that slack has been taken up. Unemployment is at its lowest for a decade, employment at its highest since records began, and spare resources could soon be even scarcer if the UK adopts a hard Brexit, with tight immigration controls. In these conditions, firms building the extra houses, roads and railways could find themselves bidding for additional employees and raw materials, driving up costs and prices rather than output and employment.
Rising labour costs are, of course, economists’ code for the higher pay which voters – and the Chancellor’s party – expect to gain when Brexit uncertainty settles. If that promise secures the government’s re-election by 2020, Ed Balls could well claim to be the ghostwriter denied a royalty.