The UK’s economic position has deteriorated, government revenues are lower and welfare expenditure higher than anticipated, worsening the deficit so that austerity must continue further into this decade. Because of this deterioration a combination of increased taxes or cuts must be identified in the Autumn Spending Statement in December.
That is the orthodox view. It is based on the generally accepted proposition that the structural deficit should be eliminated. This has set off widespread debate as to whether the increased scale of the structural deficit should be eliminated by increased taxes (such as a Mansion Tax) or expenditure reductions and where these should be identified, with the Conservatives placing welfare cuts at the top of their agenda.
But a recent research note put out by Roger Bootle’s Capital Economics is rocking these old certainties, and challenging the orthodox view. An article Why the UK output gap could be a chasm | FT Alphaville (register to view) sets out Bootle’s position.
The structural deficit is that part of the deficit that would exist even if the economy were operating at full potential. If we were at full potential now then the whole of any deficit would be a structural deficit.
Clearly we are not operating at full potential so to calculate the size of the structural deficit we need to know by how much below full potential we are operating, i.e. the difference between actual GDP and potential GDP – known as the Output Gap. The closer we are to full potential the greater is the proportion of the deficit which is structural. And the further we are from full potential the smaller is the proportion of the deficit that is structural.
The Office for Budget Responsibility (OBR) calculates that the economy is presently operating at around 2.6% below full capacity and from this deduces a figure for the structural deficit. It is the deterioration in the OBR’s figure that is putting pressure on the Coalition to find further cuts or tax increases.
So, what is Bootle saying?
We don’t think that it is out of the question that the economy was close to its potential in 2007 and that very little output has been permanently lost in the recession. On that basis, the output gap would be about 13% of GDP.
Even a highly cautious view of the situation still has Bootle’s estimate for the output gap coming in at 6%. If we were to take his 6% figure, Bootle concludes that, “this implies unnecessary fiscal consolidation under current plans of about 2.5% of GDP, or £35bn in current prices”.
As Izabella Kaminska concludes in the FT, “And that means… a) fiscal and monetary policies may be far too tight and b) there could be plenty of scope for the economy to grow strongly without inflation rearing its ugly head”.
So, why are our leaders allowing the debate over the Autumn Statement to be framed around the Welfare v Mansion Tax issue, when they could be calling into question the need for £35 billion pounds of cuts and when we could be arguing the case for a significant non-inflationary monetary and fiscal stimulus?
* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams