Refuting the charge that he opposes “green crap”, George Osborne has become a recycling champion. His Autumn Statement is built on re-announcements of existing projects (including the £15 billion road programme and Bicester Garden City), and re-allocations within existing budgets (as with the NHS’s extra £2 billion).
This is principled economics as a well as clever politics. The chancellor cannot raise government spending, especially if he wants to offer pre-election tax cuts, because of the overshooting fiscal deficit. Originally promised for 2015-16, a balanced budget now looks hard to reach even for the revised target date of 2017-18. Public sector borrowing, projected in March’s budget to fall to £86.6 billion in 2014-15 (from £98.2 billion in 2013-14) was actually £3.7 billion higher in the first half of the financial year.
Osborne can’t be blamed for this delay in rebalancing the budget – and the resultant longer, larger rise in UK public debt. His only mistake was to promise a deficit cut that was not economically feasible. Basic macro-economic accounting makes clear that when the private sector saves more than it invests, and the country can’t export more than it imports, the government will stay in deficit, spending more than its taxes bring in.
Cashing in
Britain’s households (and the banks they borrowed from) were caught with excessive debts in 2008 and had to reduce them. A private savings surplus was inevitable unless non-financial companies stepped up their investment. The eurozone crisis quickly ended any chance of the UK reversing its chronic current-account deficit.
So the chancellor’s promise of rapid deficit reduction required not only public spending cuts and revenue increases, but also a strong revival in private sector investment. Scope for this existed, in the form of the private business cash piles built up after 2008. But few firms were ready to spend these – or to borrow for investment – when demand was subdued and credit lines still fragile. Instead, spurning Treasury temptations of lower tax and deregulation, they joined households in saving or paying down debt.
Recognising that exports and investment couldn’t drive recovery, Osborne took the only other option – crushing the private sector’s inclination to save. Low Bank of England interest rates, below inflation for much of the time since 2008, were a major step towards this. Funding-for-Lending (FLS), which gave commercial banks enough cheap funds to stop them competing for household deposits gave a decisive extra push. FLS is now extended for another year, with an additional £500m to support small-business lending.
Safe as houses
When banks’ preference to use FLS for mortgage rather than business lending led the Bank of England to close this route the Treasury re-opened it with Help-to-Buy. This enabled low-income households to buy houses with the government lending them a percentage of the price, lowering their down-payment and allowing lenders to provide the rest.
By reviving the mortgage flow, these schemes have already lifted house prices close to their pre-crisis peak in many areas – and above it in London. This has enabled owner-occupiers to escape the threat of negative equity without having to save more, and those with capital gains can once again borrow against them. The return of “equity withdrawal” contrasts sharply with the US, where house prices are still well below their 2005-6 peak. Unsecured debt is also rising again, enabling households to spend more despite little real income growth.
Because house buying and building count as as capital spending in the national accounts, these policies appear to have unleashed a long-awaited investment boom. Third-quarter investment was up 7.1% from a year ago, extending what is already the longest upturn since 1998. But this is entirely due to new investment in buildings; spending on capital equipment is still falling year-on-year.
Smash the piggy banks
Subdued saving will remain essential to growing GDP and shrinking fiscal deficits, according to the Office of Budget Responsibility. Its latest assessment shows that the proportion of household income saved, almost 12% in 2010, had halved by 2013. After reviving to 6.6% this year, it is forecast to drop to 4.8% by 2019.
Can an economy sustain a return to growth and balanced budgets by saving less, rather than investing more? The perilous result is that UK household debt has started rising again, well before public debt starts to fall. Financial and non-financial business debt will also increase if present policies succeed. This makes the UK recovery extremely sensitive to any increase in interest rates, and explains continued reluctance to raise them despite fears of another asset-price bubble.
As his national infrastructure plan grabs headlines, the chancellor will inevitably be asked why he didn’t step up public investment in 2010, instead of subsidising private investment while discouraging saving. The growing “grey vote” is one reason. Care has been taken to ensure that retirees gain more from rising state pensions and relaxed draw-down rules than they lose from chronically low annuity rates.
It’s also hard to explain to voters, in a soundbite, how extra borrowing for investment in 2010 could have brought lower budget deficits by 2015. The “multiplier effect”, driving faster production growth, makes this possible. But the two Eds (Balls and Miliband) in Labour have struggled to convey it. Osborne’s counter-claim – that costlier homes make us richer – is just as paradoxical, but an easier one to sell.