Nuggets hidden deep in the Green Budget

  • 1 February 2012
  • From the section Business
  • comments

We used to read the IFS Green Budget to find all the unexploded bombs that were lurking in Britain's public finances.

There are fewer to find these days, because most of the big ones have already been detonated, either by the financial crisis or the Office for Budget Responsibility (OBR). But today's report still has some interesting nuggets, even if it does take a while to find them in its (count them) 251 pages.

On the big picture on borrowing and growth, the think tank does not stray far from the official OBR story.

With Oxford Economics, which has provided the macroeconomic analysis in this year's report, the IFS expects growth to be somewhat weaker than forecast by the OBR, but borrowing by 2015-16 to be slightly lower, thanks to slightly stronger tax receipts.

Many economists have suggested that the OBR is underestimating the amount of spare capacity in the economy. The IFS agrees, but there is not much in it. They reckon the "output gap" (the extra slack in the economy) was 3.2% of GDP at the end of 2011. The OBR says it was about 2.5%.

If there had been no permanent hit to output from the recession, that gap would now be well over 10% of GDP.

As Kevin Daly from Goldman Sachs noted recently, the official story that we have permanently lost at least 7-8% of our national output in this crisis implies that the past few years have done more lasting damage to our economic potential than either World War II or the Great Depression.

You might wonder whether that is too pessimistic, but the IFS is willing to sign up to this basic view, as are most official forecasters such as the IMF and the OECD.

Looking ahead, the IFS is actually gloomier than the OBR when it comes to the likely growth in Britain's potential output over the next few years, which it says will average just 1.6% a year between 2012 and 2016. In 2012, it thinks our potential output will grow by just 0.6%.

That compares with an average of 3.2% a year between 1997 and 2006 when growth was boosted dramatically by immigration and the mid-nineties investment boom.

Does the poor state of the economy call for a Plan B? The IFS says no. In its view, there is no room for any permanent loosening of fiscal policy, and precious little space for a temporary one either.

It's the familiar catch 22: a small change would not do much to help the economy, but a large change would so hurt the government's credibility that it might not do much good either.

Like the IMF, the IFS does think the case for a temporary stimulus is stronger than it was, and would be stronger still if the economy got any worse.

There are some suggestions in the report for what the government might do, but the IFS is not pushing them yet. In the press conference, IFS director, Paul Johnson confirmed it was "sitting firmly on the fence".

So far, so unexciting, but here are a few other nuggets that I took away from this substantial report:

First, it has some very interesting analysis of the cuts to local authority spending, showing how urban and relatively poorer authorities have been forced to cut more than rural, more affluent ones: both in absolute terms and as a share of their initial budgets.

This is largely because the poorer ones were also spending more to start with, but the difference is striking, nonetheless.

Related to this, the IFS also shows how different local services have been affected by cuts. Spending on planning and libraries has been slashed, but spending on rubbish collection has actually grown slightly, with 1.7% real growth between 2009 and 2012.

There have been grassroots campaigns in support of libraries and rubbish collection: on the face of it, rubbish beat books.

A second useful contribution here is the comparison between Britain's recovery, and those of our trading partners.

As you can see, we don't come out very well. In fact, of the G7 economies, only Italy has had a weaker recovery.

Is Ed Balls right to blame the government for this poor performance? The IFS doesn't answer this directly, but the third nugget I took from this report is the analysis of how the borrowing forecasts have changed since Alistair Darling's last budget in spring 2010, and the likely explanation for these changes.

As it happens, the current forecast for borrowing in 2016-17 is very similar to what Labour was forecasting in 2010: around £24bn.

Labour would say that demonstrates that the extra tax rises and spending cuts introduced by the coalition have been a waste of time - indeed, may even have hurt borrowing by tanking the recovery.

There's a complicated answer to that question in this report, but the bottom line is that the IFS does not really buy the Ed Balls version of reality.

In the end, it says the borrowing forecast for 2016-17 is much the same as it was in 2010, only because extra austerity has largely offset the extra structural borrowing identified by the OBR since 2010.

The think tank does not think the extra borrowing has been caused by the extra austerity, or not very much of it. It says the "error in estimating the size of the policy impact would have to be implausibly large to lead one to conclude that borrowing would actually have been lower" without the government's extra cuts.

Not a great headline, perhaps - but another small poke in the eye for Ed Balls from the guild of independent economists.