Kallum Pickering, senior UK economist at Berenberg
Britons should better get used to austerity.
Even though the U.K. government has mostly fixed its short-run fiscal problems caused by the global financial crisis, the long-run challenge of keeping fiscal policy on a sustainable path has grown even bigger, according to the latest economic projections published alongside Wednesday’s Autumn Budget.
Over the medium term, U.K. fiscal policy looks to be heading towards calm waters. Combining the progress made under then-Finance Minister George Osborne from 2010 until early 2016 with the tax and spending plans announced on Wednesday by the incumbent Philip Hammond, will manage to get the annual fiscal deficit down from a peak of 8 percent of GDP (gross domestic product) in 2009 to less than 2.5 percent this year, and eventually to close to 1 percent by early next decade. This should be enough for debt as a percentage of GDP to begin to fall gradually from around 87 percent of GDP from next year onwards into the 2020s. This is good news.
But looking further out, U.K. fiscal policy appears to be heading towards a storm. Back in January, the Office for Budget Responsibility (OBR), the U.K.’s independent fiscal watchdog, projected that U.K. public debt will rise again from the 2030s onwards to nearly 250 percent of GDP by the 2070s. Rising health, state pension and long-term social care costs linked to demographic factors are likely to cause the fiscal deficit to surge again. U.K. public sector debt is projected to reach highs not seen since World War II.
It gets worse. Keep in mind that the projections made in January assumed that productivity growth, the major determinant of economic growth, would average 2 percent per year into the long run. Yesterday, the OBR downgraded this judgement to 1.3 percent. While productivity growth has declined across the advanced world in the past decade, the Brexit-stricken U.K. is suffering an extra hit by weakening the economic ties with its biggest market, the EU.
In this new context, the earlier forecast that debt would rise to 250 percent of GDP within 50 years looks like a significant underestimate, to put it mildly. By reducing projected growth rates for wages and profits, the new lower outlook for trend productivity growth steepens the U.K.’s future fiscal hill. Unlike revenues from taxation, which mostly rise and fall in line with the rate of economic growth, future costs coming from the ageing population are independent of economic factors.
The U.K. is not alone. Other advanced countries, including the U.S., have similar or often worse demographic trends and are heading in the same direction. Few major advanced nations seem to have prepared for this by fixing the roof while the sun is shining, with Germany, often criticized for running “excessive” fiscal surpluses, among the exceptions to the rule.
With an early course correction to reduce planned spending or raise productivity, the U.K. could probably avoid the worst of the still-distant storm. But Finance Minister Hammond’s basket of policies announced Wednesday that included, among other things, measures to boost housing, cuts to income tax, and modest handouts to raise R&D (research and development), fall short of what is needed to raise the U.K.’s long-term prospects. In the end it could be that, to offset the Brexit damage, Britons will have to work longer for a comfortable retirement.
On a long-term view, Hammond missed an opportunity with Wednesday’s budget. If the U.K. could get its public finances in order for the long haul, it would demonstrate that it is committed to solving its problems. In a climate dominated by fears that the U.K. is harming itself by exiting the EU, it would have been well timed.
Kallum Pickering is a senior U.K. economist at Berenberg Source CNBC International