CentreRight

Benefits to be raised in real terms

In the PBR, chapter 5, we read:

Box 5.1: The effect of negative RPI inflation on the value of tax and benefits
The Government’s economic projections show RPI inflation as negative in September 2009. This means general prices using this measure of inflation are expected to fall. RPI inflation for that month is used to index income tax, tax credits and national insurance allowances, thresholds and limits for 2010-11. September measures of inflation are also used to index social security benefits.

With projected negative RPI inflation, the Government would maintain the cash value of tax allowances and thresholds, and the RPI-indexed social security benefits, consistent with statute. Holding these constant with lower prices means that in 2010-11, their real terms value would rise in relation to RPI, and that people would be better off in real terms. Analysis in real terms shows the effect on tax and benefit changes in terms of people’s purchasing power.

The basic State Pension is indexed by RPI inflation or 2.5 per cent, whichever is greater. This means that there will be an even larger real terms benefit for pensioners in 2010-11. Some benefits are uprated by earnings, and negative RPI inflation increases the real terms value of those increases. For 2011-12, when RPI inflation is projected to be positive, allowances, thresholds and benefit levels will be increased from their 2010-11 levels in line with standard indexation. This will maintain the real terms gain from 2010-11 for future years.

In other words, the government is committing that, even if deflation races away, benefits will not be cut in cash terms and the pension will always rise at at least 2.5%.  Committing to real rises in benefits whilst trying to keep overall expenditure to an ambitious 1.1% growth rate seems like a challenge.  Why should deflation change the way that benefit and pension indexation is done?  And can we really afford an open-ended commitment to raise benefits and pensions in real terms at a time when budget deficits are so out of control and debt is to rise so rapidly?

Three kinds of crisis, and what will and won't work in addressing them

Let's distinguish between three forms of crisis that firms - in any industry - can face:

1. Liquidity crises
2. Solvency crises arising from past losses
3. Future profitability crises

Progress of Recessions, 1973-2008

In the graph below I represent the three recessions beginning in 1973Q3, 1979Q3, and 1990Q3, and add in (with the dashed line) how the PBR suggests the recession beginning in 2008Q3 will progress (on the horizontal axis we have the number of quarters after GDP peaked just before the recession, whilst on the vertical axis 100 is the level of GDP just before the recession began).  We see the very long but shallow recession of the early 1990s compared to the much deeper but shorter recession of the 1980s, and then the volatile recession of the early 1970s.  The PBR suggests that the recession will be shallower than the 1990s and much shorter than any of these three previous recessions.  So Darling's story now is that "the worst crisis in 60 years" will issue in the shortest and mildest recession for decades.  Do we think he really believes this?  But if these growth figures aren't achieved, then the government's debt figures will be much worse than those announced on Monday.

Update: Now with improved version of graphic illustrating both the worst-case and best-case scenarios from the PBR (click on the graphic for an enlarged version).

Government commits to extremely tight spending control

In an altogether extraordinary pre-budget report, one of the most extraordinary moments was not even cheered or gasped at at the time.  It was when the Chancellor announced the rate of real terms spending growth from 2011 on.  Read it at paragraph 6.33 here:

6.33 The Government is determined to support the economy in the short term and continue to improve and invest in public services in the years ahead. To secure the improvements and investment within a framework that delivers sustainable public finances over the medium term, the 2008 Pre-Budget Report therefore also sets assumptions for spending growth in the period from 2011-12 onwards:

• total spending will continue to grow by 1.1 per cent a year in real terms over the years 2011-12 to 2013-14 ;
• current spending will grow by 1.3 per cent in 2011- 12, 1.2 per cent in 2012-13 and 1.1 per cent in 2013-2014; and
• public sector net investment will remain at historically high levels moving to 1.8 per cent of GDP by 2013-14.

So, after the epic slurges in public spending in recent years, the government is now proposing to have spending rise only 1.1% per year in real terms from 2011-2014.  That, if delivered, would be an extraordinary turnaround - tighter that ConservativeHome called for, tighter than many commentators argued was even possible.

VAT, Income Tax and Deflation

This PBR has been re-spun so many times it must be dizzy.  However, in lieu of any alternative (other than - perish the thought! - hearing the announcement in Parliament rather than relying on gossip to favoured journalists), let's assume that there is going to be a cut in VAT.

This isn't what I'd have done.  It is, however, what Ken Clarke and the CEBR recommended.  I consider this approach unnecessarily dangerous in a way that suggests the concept of the tax cut is misguided - it's only a good idea (only better than leaving well enough alone) if the effects would be the same as an income tax rebate, in which case why not simply cut (rebate) income taxes.  I shall explain.

What would Lilico say in the PBR?

The Conservative Front Bench has chosen its path, so it won't be able to argue the line that I would.  But for those fools among you daft enough to have read my many missives, since July, on the issue of fiscal stimulus this autumn, it may be of some independent interest to understand what I would have recommended we do had anyone on the Front Bench paid any attention to what I thought, and the ways I expect Darling to get it wrong.

Are you ready for the General Election?

I think there is a very good chance that Brown will call a General Election early in the New Year (January, February), off the back of this PBR.  He will say something like "I told you in October 2007 that I wanted the opportunity to expose the weaknesses in Conservative economic thinking.  Some of you did not believe me at the time, but I feel that my case is now clear for all to see in a way that perhaps it wasn't back then.  We now face the worst economic crisis, around the world, for many decades, and we have a clear choice: the fiscal stimulus package we have proposed, which will get the economy back on track, or the Conservative path of cutting expenditure, no fiscal stimulus, passing by on the other side whilst ordinary people suffer - making the recession longer and deeper.  There is a choice to be made, and I believe that it is right that the British people get to make that choice.  So I have been to see Her Majesty..."  I don't believe that Mandelson will let him wait until the real recession gives us power by default.  It's nearly "good to go" time folks...

Austerity and the burden of the nationalised banks

The Conservative position is that the British government is at risk of being unable to fund its debts, and is at material risk, therefore, of being unable to service the additional debt that would need to be taken on in order to deliver the sort of tax-cut-focused fiscal stimulus I have argued for since July and that is now favoured by, inter alia, the British government, most of the quality and tabloid press, and almost every major trade association.  Instead, since there is a risk that additional borrowing might lead to sovereign default, the Conservatives propose to cut or reduce the growth in public expenditure.

Obviously this isn't what I believe (specifically, I don't believe things are that bad - I don't believe the UK government is going to be regarded as at risk of sovereign default and unable to service its debts), but it's at least an arguable position, and our move on public expenditure yesterday was a welcome move towards some consistency - making our policy coherent, if not correct.  Obviously no-one listens to me, but just in case, I note the following.  If it were true that Britain were on the cusp of being regarded as at risk of sovereign defulat, the main contributor to that would indubitably not be the government's fiscal policy.  It would be the government's assuming of the liabilities of the UK's nationalised banks.  So if the Conservative position is now that we should adopt an Austerity approach and control growth in the government's debts, should we not be seeking whatever scope might remain for the government to wriggle out of its nationalisation "recapitalisation" programme of the banks?

OK. Austerity it is. That is at least a strategy.

Today, we announced that we plan to spend less than Labour currently plans for 2010.  Good!  It was a long time coming, but no less welcome for that.  It's also good that today's commitment on spending was free-standing - not a consequence of some tax commitment.  I would have preferred us to begin with a deeper analysis of the role of the State and the Market, and how best to deliver those things best done by the State, but it is infinitely better for us, when thinking long-term and strategically, to make spending decisions first with tax decisions following rather than leaping in with tax cut promises (either promises to cut taxes or not to cut taxes) without having first worked out what we wanted to spend.

Where now for the "fair fuel stabiliser"?

It is being rumoured that we might ditch the Fair Fuel Stabiliser, unsure how to finesse questions about how much it would be causing us to raise fuel taxes at this point.  In my view (though, having been the original author of the concept back in 2000, I admit to bias) that would be an error.

The problem we are currently experiencing with this concept is that it was mis-pitched.  We presented it as some sort of response to recession (at conference we quoted it as one of our main responses to the recession).  But that's not what a price-stabilising fuel duty is about.  A price-stabilising fuel duty is a green tax, not an anti-recession measure.  The concept is that the very high level of fuel duty reflects the fact that government wants petrol prices to produce a certain incentive to seek alternatives to petrol and limit consumption of petrol - so as to limit the growth in carbon emissions.  To achieve this, government effectively picks the price of petrol.  But it would be best to pick that price competently - not allowing the government's choice of price to be completely derailed by fluctuations in the price of oil.  The price-stabilising fuel duty does this.

I think there is still time to reposition on this.  We could make the price-stabilising fuel duty the centre-piece of our green taxes agenda - an illustration that green taxes don't have to involve a net increase in taxation.

Reasons for getting rid of Labour: Economic mismanagement

I never believed that Gordon Brown was a wonderful chancellor.  I have written before about what I saw as the seven key planks of Gordon Brown's economic policies:

1. Operational independence of the Bank of England
2. A modification of the previous inflation target to include a specific value as well as a band
3. The use of various "fiscal rules" to guide fiscal policy
4. The concentration of all financial regulation into one super-regulator, the Financial Services Authority (FSA)
5. A Tripartite framework for promoting financial stability including the Bank of England, the FSA, and the Treasury
6. A "taper relief" system for capital gains tax whereby investments kept in a business for a longer period were subject to less tax that those extracted quickly, as soon as capital gains were made
7. The abolition of the previous "surplus Advance Corporation Tax" regime, a reform intended to encourage longer-term investment and discourage over-payment of dividends

None of this has, in the end, worked well.

You read it first here

Even though I had been suggesting since February that the budget deficit might rise to exceed £100bn, from July I started recommending that we position ourselves to favour a borrowing-funded tax cut, since Gordon Brown would need to do that in the Autumn.  In September I firmed up this recommendation, offering an explicit figure of £30bn.  At each stage, here, my suggestions met with scepticism or even outright derision or claims that I could not be serious.  Reality has now caught up - the Telegraph is reporting the IMF calling for tax cuts in Britain of £30bn.  Like everyone in my profession, I get lots of things wrong.  But that doesn't mean you should pay us no attention.

Partisanship, Sterling, Osborne, etc.

Attacks on Osborne for "talking down Sterling" are absurd, for at least three reasons:

1. We don't have a fixed exchange rate, so the issue of undermining confidence in the will of politicians to maintain the exchange rate simply does not arise.  It is entirely the job of Opposition to challenge the government's economic policies.  If only they had chosen to do so over the nationalisation of the banks, instead of proclaiming (unilateral) bipartisanship, we might be slightly better off than we are now.
2. Having a weaker exchange rate at this time would (if it made any difference at all, which is less obvious than usually assumed) probably be rather helpful to the economy, given that we are struggling against controlling forthcoming deflation.
3. Like virtually every other politician, because we do not have a fixed exchange rate and hence the level of the exchange rate is not a political question but a market one, George Osborne has no idea whatever where Sterling is going, and does not have sufficient credibility to move markets.  Financial markets are not interested in George Osborne's foreign currency speculations.  It is just possible, I suppose, that he might have better information than the Market concerning the likelihood and size of any spending increases or tax cuts Alistair Darling is about to announce - but he has no idea whether these announcements would be greeted by a rise or fall in the value of the pound.

On the other hand, Osborne's comments are plain daft.  Really.  I take no pleasure in disagreeing with Osborne so blatantly - and have waited until probably no-one is looking before doing so just in case there were the remote possibility someone might care about what I think.

I wept, but let's not become too quick to seize kids

The Baby P case is very distressing.  I confess that I haven't briefed myself very closely on it, because reading too many details made me cry.  Many people are saying that the social services failed to act when they should have done.  Perhaps that's right.  But I would urge one thing.  Remember that there have been a number of past high-profile cases in which child abuse was alleged, local authorities did take children away, those allegations were later concluded to be false, and the local authority and the social services profession in general were roundly condemned as interfering busy-bodies who create misery for innocent parents - particularly by Conservative MPs and right-leaning journalists.  Partly in response to the issues arising in such cases, social services have a number of hurdles that need to be overcome before children can be taken away from their parents.  This surely must be the right instinct.  We want to protect children - of course - and cases like Baby P are harrowing.  But the state should have to follow "proper procedures" "strict protocols" (no matter how callous and irrelevant that phrase seems in a case like this) before taking children away from their parents, and the natural tendency should be to aim to leave children in their parents' care, even though that inevitably means that there will be cases in which social services look at a situation, decide not to act, and abuse occurs.  I'm not saying that the balance was right in Baby P's case.  But we should not allow our sorrow and (probably rightful) collective guilt over such a case to lead us to formulate new rules that impose life-breaking misery upon innocent (or salvageable) parents by needlessly taking away their babies.

The final resort

You may remember a few weeks back I said that the government was down to its third-last option (the non-nationalising version of the bailout) in dealing with the economic crisis, and that after that there was only nationalising the banks and something that I didn't even dare to write down.  I mentioned it in passing in this post, but didn't dwell on the point for obvious reasons.  This morning, someone else dared to write it down.  As I've said before, we're not there yet.  But the fact that serious people are discussing printing money, at some point in the not too distant future, to try to address our economic situation should, perhaps, be a signal to our Treasury team that £2.6bn of job subsidy wheezes isn't gonna to cut it.  This is well beyond momentary politics and tactical questions about tomorrow morning's headlines.  It's well beyond the issue of what is embarrassing for our leaders in terms of admitting their past mistakes, or whether a change in tack would force us to shuffle the personnel.  It's also well beyond the question of whether we maximise our majority at the next general election, frankly.  We need to be arguing, urgently and then consistently, for what is the best thing to do.

RE: RSA Event: The Age of Austerity: Keynes and the Crisis

Here is Michael White's article about the event

Matthew Taylor's blog about it

Text version of my speech: Download Keynes.doc

Audio of the event (I'm on from 12 minutes 20 seconds)

The Bank of England Inflation Report: Grim and Grimmer

I don't usually write you commentaries on the Bank of England's inflation report - you don't pay me enough for that.  And I'm not going to offer you much detail today.  But a few points from it are so striking that you really need to get hold of them.

First, here's Chart 5.2: GDP projection based on constant nominal interest rates at 3%:

What does it say?  It says that the Bank is now expecting GDP to contract 2% from October 2008 to September 2009, and it thinks there is a 15% or so probability that GDP will contract by more than 3% in that period.  If you compare Chart 5.2 with Chart 5.1 (GDP projection based on market interest rate expectations - which were higher) we can see the point that we knew - lower interest rates are not expected to have any effect upon this phase of the recession.  Their effects (such as they are) will come later.

State capitalism, USA

Robert Peston has noticed that the US economy is embracing the economic model of China.  Some of us noticed this a while back.

Fair enough: a socialist solution for a socialist age

Six months ago, if the Labour government had proposed to respond to what was already then the impending economic downturn by introducing a subsidy of £2,500 for any company taking on someone unemployed for more than three months, and claimed that this measure would not cost the Exchequer money - indeed, would be more likely to save a bit of money - what would you, Dear Readers have said?  What would right-wing bloggers have said?  What would the Telegraph, Times, Daily Mail etc. have said?

RSA Event: The Age of Austerity: Keynes and the Crisis

In case anyone fancies coming.  Here's the spiel:

RE: And now for the auto industry bailout...

Further to my post yesterday, I note now that VW is attempting to raise €2.8bn from the ECB.  Robert Peston asks (not wholly flippantly, he says) whether the Bank of England might soon be asked to finance Marks & Spencer or Taylor Wimpey.

Responsible tax cuts

Fraser Nelson appears bored by Cameron's repeated use of the term "responsibility" in his speech to the Conservative Women today.  But I think he misses the subtle undertones of what's going on here.  The Front Bench wants to retain the claim to "fiscal responsibility" whilst at the same time advocating tax cuts as a response to the recession.  So the trick they clearly have in mind is to use the term "responsibility" to creep from "fiscal responsibility" to "economic responsibility" to "responsibility for my neighbour (particularly if she's at risk of unemployment)" and, lo and behold!, suddenly cutting taxes becomes the responsible thing to do!  Clever, huh?  I like it!  (Not so sure about the rest of the speech, especially the bit about hysteresis, but we can worry about that later...)

And now for the auto industry bailout...

From PoliticsHome:

Union calls for £13bn government fund for car industry 14:17 | 10/11/2008

Tony Woodley, General Secretary, Unite

Sky News

Mr Woodley said he had called on the government to provide a £13bn fund to support the car industry during the economic downturn.

Highlighting the threat to UK car manufacturing from the potential collapse of General Motors he called on the government to: "work with President Elect Obama to support General Motors so it survives".

He also called on Lord Mandelson: "In the mean time to approach the Chancellor for a £13bn fund that could be used by the whole industry ... for loans at decent rates to keep our industry alive".

No further comment necessary from me. [Actually, I've changed my mind.  A brief further comment.  I don't really see why one would say that Woodley is wrong, here, if one has supported the bank bailouts (which I didn't).  Collapse of the large US car companies would certain have systemic effects for the US economy, and there could well be spillover effects into the UK car industry that would lead to regional blight in the UK.  If the US can find trillions to support the banks there, why not a few tens of billions for the auto industry, and if we in the UK can find £500bn to support our banks, why can't we find £13bn to support the car industry?  Does anybody want to suggest something David Cameron could say to oppose the establishment of such a fund for the car industry that would not expose him to the question: "So why did you support the bank bailout, in that case?"]

Osborne commenting on tax cuts in the FT

Writing in today's FT, Osborne says:

Today, we must let the automatic stabilisers function. But as Lord Burns, former permanent secretary at the Treasury, warned last week, borrowing beyond that without being clear how the bills would be paid would be “very dangerous at this point”. “We begin from a position of a structural deficit. Adding to that structural deficit can only increase the problems subsequently,” he said. I agree. Spending our way out of recession will not work. Targeted tax cuts would help but they must be properly funded. Any tax cuts must not permanently increase the structural deficit and must be combined with a strategy to reduce it over time. If they are not, Britain’s international credibility will be further imperilled, future generations will be burdened with even more debt and a recovery would be threatened by the prospect of large tax rises. We would be sowing the seeds of the next crisis.

I agree with Osborne here.  It is very important that any activist fiscal policy employed at this stage involves a clear strategy for preventing the structural deficit from deteriorating further.  That is why I have proposed the use of temporary tax rebates, so that the underlying tax rate is unaffected and hence the medium-term structural deficit is affected only insofar as the policy affects the growth rate of the economy.  In my view the use of a Reagan-style cut-taxes-first-find-the-money-later cut would be unwise, given where we are starting from.

So, the Conservatives have an economic policy...

From this morning's press it appears that the Conservatives are about to propose a change in economic policy.  The new policy is to cut the growth in public expenditure (or perhaps even cut public expenditure in absolute terms).  I suspect that there will be general relief amongst the media (who are eager to regard us positively, if they can) that we now have something that might be termed a "response" to the recession, and as a consequence we may not be subject to particularly close scrutiny on this concept for now.  Nonetheless, not everyone will be lax, so here are a few questions to which we'd better have some kind of answer: