George Osborne must be feeling vindicated. The Office for Budget Responsibility (OBR) that he founded published a report last week with a simple conclusion: a host of risks to the public finances, including recession, make it wise for the government to continue with deficit reduction.
As the Conservative minority government argues among itself about whether to increase government spending following the poor election result, the former chancellor is clearly keen to protect his own legacy and narrative.
But should he be feeling so chipper? Osborne is surely right on one point. With a deficit still between two and three per cent of GDP — a level seen just prior to the financial crisis — and with the amount of debt more than doubled since then, more restraint is needed to get the debt-to-GDP ratio back on a downward path.
Yet hidden away in the detail of the report was evidence of Osborne and David Cameron’s absolute failure to do anything to arrest the alarming fall in productivity growth — the only way to get sustainable improvements in living standards.
Between the mid-1970s and 2008, annual productivity growth averaged 2.2 per cent per annum. Since 2008, it has averaged just 0.2 per cent.
Even now, the OBR’s fiscal projections are based on productivity simply returning, jumping to 1.8 per cent over the next five years and then rising further to two per cent from then onwards. If instead the post-crisis period is a “new normal”, future governments will either have to commit to a path of much lower spending in the long term to reflect the capacity of the economy, or else public debt will continue to explode upwards.
To get an idea of the magnitude involved, the OBR outlined how a permanent fall in annual productivity growth of just 0.1 percentage points per year would raise the public debt burden by as much as 49 per cent of GDP over five decades.
Recognising this central importance of growth to prosperity and the health of the public finances, many of us urged Cameron’s government over many years to pursue a robust pro-growth supply-side agenda. But such calls were met with a fatalism — not entirely unfounded — that government could not really do much to change trend growth, and that this was a phenomenon affecting many countries.
Certainly, the timeline suggests that factors related to the financial crisis and its fallout have had a big impact. Whether that is because of the debilitating effects of the crisis on the financial system, the nature of the response to the crisis (more regulation, sustained high levels of government borrowing and low interest rate policies), or the unsustainability of the preceding boom, remains to be seen.
In this environment though, given the huge significance of robust growth and now the uncertainties of Brexit to follow, the government surely has a responsibility to make economic growth its overwhelming priority.
The last government often did not seem interested in this. It showed no ambition to reform the tax code, did not go anywhere near far enough in re-examining the UK’s suffocating land-use planning laws, increased labour market regulation substantially, and presided over an increasingly interventionist energy policy that pushed up fuel bills for business and households.
Even though it talked a good game on infrastructure, in project selection it prioritised schemes with low benefits compared to costs, such as HS2, instead of high-impact road schemes. Even when it did talk productivity, it reached for the failed 1970s concept of having an industrial strategy.
With the economic outlook darkening again, this government cannot make the same mistake. Though in a tough spot to pass legislation given the electoral arithmetic, the Brexit process and any domestic agenda must be focused on raising the UK’s growth potential. The OBR’s work has shown that policies with small macroeconomic impacts can have big long term effects. Now is the time to deliver.