In my last piece, I outlined the expected consequences of a depreciating pound and that a looser fiscal response was the only feasible short-term policy response that would be available to deal with the massive macroeconomic shocks that are likely to ensue (an uncoordinated) NO DEAL Brexit.
Three and a half questions follow:
- What is the Boris math for the litany of fiscal promises issuing since his “inauguration”?
- Are these spending promises feasible & credible in terms of the macro-fiscal context the UK will face in a NO DEAL scenario?
- What should our response as LibDems be to unpick if not defenestrate the Tory Wafflenomics in the run-up to October 31st? The half-question I leave for another occasion, what should be our policy response to deal with the after-effects from November 1 should a No Deal actually take place.
Math on Boris’ Fiscal Promises and projected values
(…mind you we’re just a few weeks in..)
- 20,000 new police officers: £1bn (one-off)
- Rise in 40% tax threshold from £50k to £80k: £10bn
- National Insurance contributions at higher trigger: £11bn
- Schools: reversing cuts in Education envelope: £5bn
- Health: Unclear but: 20 New hospitals £1.8bn + wooing female voters £2bn + ??promised £350m per week: £3.8bn – £20bn
- social care: £10bn
- new railway Manchester – Leeds: £2.1 – £3.6bn depending on sources, assume £3bn
- Help to farmers: £0.5bn (but is this just for the Welsh lamb?)
- No-Deal Planning: £2.1bn (let’s assume £100m no-deal advertising part of this budget line)
- Unbudgeted thus far: other sectors e.g. Fisheries, medicines, food shortages, …you get the picture…cost of increased policing…
Totting these figures gives £42bn excluding the £350m/week which alone would imply a further £18bn…and per year if the red bus promise is to be kept strictly. Large numbers in absolute terms (a billion has nine zeros) but not in relative terms as the UK economy is £2 trn in value (a trillion has 12 zeros), meaning that £42bn equates to around 2% of GDP or 5% of the current budget and therefore chunky but not a huge fiscal expansion…of itself..
To give some context, I include Chart 1 from the 2018-19 Budget document from HM Treasury – itself taken from the independent Office for Budget Responsibility or OBR.
The UK budget for 2019-20 was a cool £842bn of which the 2 largest components are Health and Social Protection, accounting for £422bn or exactly 50% of the budget.
So the implied fiscal loosening thus far is not eye-watering and certainly feasible. But where is the financing from and what happens if, as expected, the economy goes into a massive recession following a NO DEAL Brexit…in that case the fiscal deficit would rapidly balloon as a share of a shrinking GDP… additional fiscal fire-power would be needed for each of those bits of the pie in Chart 1.
Show me the Money
(Aka Tom Cruise as Jerry Maguire.)
Would these measures accounting for 2% of GDP expenditure be enough to ward off a major, say, 7%-10% economic compression in GDP in year 1 and a likely 5% further reduction in year 2 following a NO DEAL? (The only recent comparable to what the UK would face is the collapse of former Soviet and Yugoslav federations where real output collapsed by up to 30% and took several years to bottom out).
- Promises or pledges are not necessarily budgetary “commitments”. And are not, to use the jargon, “appropriations” ie actual disbursements for whatever purpose. There can be a lot of spin to dress up existing funding or to extend out “ new” expenditure over several years so as not to materially affect the annual budget balance. So, in one sense, the Tories can make headline promises and we’ll need to see the detail when the new budget statement comes out.
- A genuine rise in annual spending takes time to have impact, especially for capital spending and for infrastructure projects that take time to plan, procure and to commence. Current spending: ie wages, social care etc. can be ramped up quickly and was one of the mechanisms deployed, oddly enough… by the much-maligned EU… through targeted budgetary support in conjunction with the IMF/World Bank/African Development Bank, as part of the global response to assist 30 odd Low Income Countries after the Financial Crisis in 2007-08 to stop hard pressed ministries of finance simply cutting back on Education and Healthcare – and which worked. But the UK isn’t a fragile poor economy so we’d need to get some real sense in granular detail of what this extra recurrent budget would be for and the implied impact.
- Every 1% cut in GDP means a cut of £20bn in British Income, so a 7% GDP hit would imply a hit of £140bn. There would then be ripple effects across into private sector balance sheets – most notably on housing –and on government finances and “risk premium” on UK debt (ie how much more foreign investors would want to hold UK debt), a further crashing of the pound, higher imported inflation, further reduction of the purchasing or “real” value of government expenditure, cuts in real wages…and so the cycle would continue…and without the theoretical self-correction beloved of free-marketers as we’d be bang in the middle of a trade conflict with the rump 27-EU.
- Financing: so £42bn or 2% of current GDP isn’t too difficult but the reality would be a cascade effect and a potential “fiscal bail out” of say £200bn, and annually over several years…implying a possible rise in UK debt by a £1000bn ie £1trn. And I exclude any possible bank runs given the Bank of England’s assessment that they’re super ready for any eventuality.
- For what its worth, the posited fiscal expansion of £42bn could largely by raiding the safety cushion or “fiscal headroom” of around £27bn built by ex-Chancellor Hammond but then that would basically mean that the UK becomes “fiscally headless”….
Conclusions
- The promised £42bn, even if genuine, would pale into insignificance set against a self-enforced economic collapse with both demand and supply shocks (possible next piece) that could easily lead to a 7-10% economic shock and a massive explosion in budget deficits and deficit financing of £200bn+. The exact numbers aside, the likely trend of a NO DEAL Brexit is fairly clear, and we need to get the message across of the macro-fiscal and real societal costs of a No Deal scenario. The real impact of these numbers, alas, would be a massive haemorrhage of people’s jobs and livelihoods, food & medical shortages coupled with mass unrest.
- This bleak potential outlook cannot be unknown to Numbers 10 and 11, nor to the EU negotiating team backed by DG ECFIN and finance ministries in the main EU capitals. Leaving aside the possible political dimension for parliament to put a stop to this course through a no-confidence vote, in pure “game theory” the Boris do-or-die date of 31 October therefore doesn’t stand up– its simply not credible.
- Whether the PM is manoeuvring for an extension or not, we need to continue to whittle away the lack of economic and financial logic of the NO DEAL scenario.
* With experience across academia, think tanks, central banking, EU Accession and reforms across 40 developing and transition countries, Dr Rupinder Singh works with multilateral organisations and governments as an independent adviser. He is an Executive member of Liberal International (British Group).
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10 Comments
Under our beloved leader “Young Winston Depeffle” we have discovered WiffWaff economics based on the intrinsic value of unicorns.
Meanwhile under the leadership of Admiral wee Mogg the brave Brexiteers ready the massed steam boat squadron in Grimsby. You might have thought were are our Brexi’s and Lexi’s well, some have joined Tinkerbells flying fairies, some have rejoined the Imperial Unicorn Hussars aka the Blood Red Uni’s, but most are filling the post of master mates and cabin boys in Grimsby. No prizes for guessing who fills each role.
I think in plain English I should reiterate my point
“Every fact you say is true, but it makes no difference, they don’t do facts, they do delusional emotion, no amount of facts will change that”.
@ Rupinder,
I don’t know where to start on this! Frankie, above, for once makes more sense than the OP!
Maybe I should just highlight:
“a potential “fiscal bail out” of say £200bn, and annually over several years…implying a possible rise in UK debt by a £1000bn ie £1trn.”
You’ve completely overlooked that the Govt’s income is highly dependent on its spending. In fact the only reason the Govt can have an income in ££ in the first place is because it previously spent those ££ into existence.
£200 billion extra spending is quite fanciful. But whatever the extra spending might have to be to keep the economy ticking over properly, regardless of whether or not we leave the EU, most of it will come back as taxes in one way or another. Where else can it go as it is spent and respent? So to claim £1 tn, even if we do increase spending by £200 bn is just plain wrong. Tax receipts will also rise.
Should the Govt spend more? Maybe. It all depends if there are available resources in the economy. If there are then we do have “fiscal headroom”. If there aren’t we likely create too much inflation.
That’s all there is to it! “Fiscally headless” ??? Goodness me whatever next?
You might want to read how to avoid a recession:
http://bilbo.economicoutlook.net/blog/?p=42816
Thanks for this enlightening clarity, Rupinder. I have been to some lectures on Modern Monetary Theory, and also some on how proponents of MMT can rebutt crticisims of the theory even without fully understanding all the detailed economics. The basic point of MMT it seems is that the UK need not worry about increased spending financed by more international borrowing and higher taxes on the higher paid. This is because economic growth, the theory goes, is largely caused by government spending, which it then gets back through increased tax receipts as the economy grows, via ‘multiplier effects’ (ie higher welfare spending puts more money in the pockets of consumers which boost the economy etc etc). Thus the 55% of the population that pay income taxes, and consumers more generally, don’t need to be taxed extra for extra services from government and for infrastructure spending. Do you agree ?
@ Paul,
“The basic point of MMT it seems is that the UK need not worry about increased spending financed by more international borrowing and higher taxes on the higher paid….”
No it isn’t.
The basic point is that taxation is required for various reasons. The main one is to create a demand for the currency and give it a value. It is an anti inflation device. Too much inflation, particularly of the demand led type when the economy is running too hot, requires higher taxation and/or reduced govt spending.
The next reason would be one of social justice. We tax the rich more to even things up. At the same time we recognise that they do have a lower propensity to spend so it doesn’t have the same anti inflation effect. Another reason would be to discourage certain activities like smoking. We don’t ban it outright but we do impose a high tax.
Hi Paul. Short answer, I don’t buy the MMT argument – at least for the UK, particularly given the macro turbulence likely in the event of a no-deal Brexit.
Negative yields on the bond markets (ie bonds will yield negative income for holders to maturity) appear to be the “new normal” for mature economies but may be a reflection of a general shift of global funds to safety of bonds. Negative yields may give succour to the left-leaning US Democrats that have been pushing for an MMT-style Keynesian Mark II economic model that the US can massively expand fiscal expansion without threat of bankruptcy but it will come at the cost of rising Balance of Payments deficits on the capital account and higher debt payments – and which already puts a higher risk of US slowdown when the sugar rush of Trumpian tax cuts runs out of steam in 2020-21. The US remains unique as an essentially closed economy with the role of the dollar as an international unit of account gives it oomph if not substantial “seignorage” so there may be an argument that the fiscal deficit can be pushed higher to finance a fiscal expansion without threat of bankruptcy. On the other hand the Eurozone remains a case of a single monetary policy and 19 different, loosely co-ordinated, fiscal policies – so again don’t see it being relevant.
The UK is an open economy and the exchange rate is a key variable for international trade, inflation and real wages. As I said in my pieces, the key point for us is that fiscal loosening implied by the Johnson government may be feasible for a modest rise in overall net UK debt but actually a no Deal would require major fiscal expansion that I don’t think would be feasible without the markets – and the pound – crashing.
On the other hand, I think there is a potential policy aspect we should consider within the spirit that Labour has touched on –the idea of re-packaging part of the Bank of England’s QE on its balance sheet – into some form of Infrastructure bank or say into a myriad of intervention tools akin to the EU’s Cohesion and Structural Funds Policy.
Thanks for your comments Peter.
The key take-away is that the Johnsonian fiscal framework does not add up and that a tail risk of a no deal Brexit would lead to major external and internal shocks to the UK economy that haven’t been experienced outside Emerging Economies in decades. Not the specificity of the numbers..
On the points in public finance, revenue as a share of GDP in OECD countries tends to be similar at around 33% reflecting cyclical nature reflects the business cycle, although there will be structural aspects over time. As for any economic agent, expenditure is derived either from income (ie tax for a country), borrowing or reduction of savings.
But if income drops massively ie GDP tanks, then of course, tax revenue would shrink massively and in turn expenditure – even with automatic stabilisers in place. This is conventional policy practice across developed and developing economies and the impact of such shocks would be catastrophic if realised. The key point for us as LibDems is to emphasise these risks to the electorate.
If no deal Brexit can be avoided then of course there will be a significant uplift in GDP.
Of course, if there is a no Deal Brexit and the LibDems have a key seat in any subsequent umbrella coalition government, then we need to have a baseline policy response to deal with the mess!
Rupinder Singh,
I note you provide no references for your prediction of an economic compression of 7-10% in year 1 and a further 5% in the second year. The Bank of England has said there is only a one in three chance of a recession after Brexit. The OBR using IMF analysis has predicted that the UK economy would decline by 2% of GDP in 2020 and be back to growth in 2021 if there was a no deal Brexit. As you state the £42 billion figure is only 2% of GDP and some of it is for future years.
If we left with no deal I think that the government should increase its expenditure by 3% of GDP, which I think is over £63 billion. I would use £10.1 billion to carry out our costed benefits changes in our 2017 manifesto and to restore the national Council Tax Benefit scheme. I would give £16 billion to local authorities to spend. As inflation is likely to be an issue I would cut VAT by 1% costing about £6 billion, increase the National Insurance thresholds costing £8.2 billion, and use £4.5 billion to increase public sector workers wages. This still leaves £18.2 billion for capital expenditure, mitigating the effects of Brexit generally and purchasing agricultural produces which normally would be exported to the EU but not because of tariffs.
I agree with you some of this extra government spending might have to be financed by the Bank of England, but that should not be a problem. I would hope that my policies would be enough to turn the predicted negative growth of 2% into a positive figure of about 1% and so avoid us going into recession.
Hi Michael (2 part response). I have great respect for the OBR and pals at the IMF. My projections are based on a more pronounced tail risk event in the event of a no-deal Brexit.
The broader point – and highlighted in the Yellowhammer report – is that the ‘real economy’ risks are potentially far more significant and onerous than under prescribed base-case scenarios.
The highlighted the massive destabilisation that could ensue in a no-deal scenario – and significantly far worse than expected – and thus the economic case for Remain. But also, to start a conversation about our reaction function in the event of a worst case scenario.
Going into the weeds, the problem with statistical or “econometric” modelling is that it is, as a framework, backward looking based on past data and prevailing economic relations between variables and non-linearities by way of a sudden economic shock/ “cliff edge” – an apt term given the discussions around No Deal Brexit – cannot by definition be fully internalised . This tends to mean that in essence the scale of major shocks have greater and more magnified effects than modelled – witness the “one in a million” chance scenario echoed by rocket-scientists who failed to forecast the the Great Financial Crisis or its real-economy impact for the likes of Goldman Sachs – and further back, and possibly of more relevance, the huge collapse of former planned economies following the dissolution of the Iron Curtain and the Comecon trading bloc – that were outside forecast models.
There is also the rather more obvious point of institutional DNA if not institutional drag and a tendency for institutions to adjust forecasts gradually.
(contd..)
I would pay more heed to market expectations which are now above 50% for a new deal, collapsing purchasing managers indices in developed economies that presage a much less benign external environment for UK trade (even without the Brexit trade issues) and the implied recessions proffered by inverted yield curves.
To sum up, one should take the OBR+ forecasts as baseline projections and,
i) the Boris maths “don’t add up” for the pre-election expenditure being announced although as a share of GDP it is not, as you have noted, not massive
ii) however, the fall in domestic demand under a no-Deal Brexit would be such a calamity that that it would mean a much much higher fiscal bail-out BILL to compensate for this and the numbers could rapidly escalate along the lines I outlined, swamping the current Boris 40-odd bn figure
iii) What I haven’t touched on – yet – and which you allude to, is what should be our reaction function under a no-deal scenario come November 1.
Thank you Rupinder Singh, for your response. What I take away from your comments is that the reason you give no references is because you don’t have any, but are using a “gut-reaction” to develop your over pessimistic view. The Yellowhammer report is not relevant as you didn’t know about it when you wrote.
When you talk about the 2008 crash you again provide no UK economic figures. At least the forecasts being made are based on, I believe, the experience of New Zealand. The fall of the Iron Curtain is not a good comparison.