Similar to what I did last year, this year I will once again analyze the new UK budget announced yesterday by the (downgraded) Chancellor George Osborne.
The initial reaction is actually better than last year, except for some policies which haven't changed and some new woeful ideas. You can read summaries of the budget from a variety of sources: Financial Times, BBC, Telegraph, Guardian, CityAM, think tanks (ASI, IEA, CPS) or watch this interesting video from the FT:
Before we move on the budget itself, the UK Office for Budget Responsibility issued their revised growth forecasts, and things still look rather gloom for the UK. Growth was revised to 0.6% this year and 1.8% in 2014. (Last year the prediction was 0.8% in 2012 and 2% in 2013 - so take the prediction for the recovery in 2014 with slight suspicion, as it always is with growth forecasts). Employment figures still seem to be increasing (even above forecasts), and with stagnating GDP this implies that productivity is still poor. Here is an interesting finding:
"Business and consumer surveys, and other cyclical indicators, suggest that spare capacity in the economy was flat or shrank in the final quarter of 2012. This would imply that the weakness in output over this period was structural and that trend total factor productivity (TFP) had contracted. As in December we believe wider indicators are hard to square with severe renewed structural weakness. So we assume that the output gap was -2.7 per cent of potential in the fourth quarter, consistent with flat rather than negative trend TFP growth over 2012." (OBR, Economic and Fiscal Outlook, pg.8)
This is in my opinion the biggest worrying sign for the UK at the moment. And I'm surprised very little is being done to fix it. Expectations of a short term boost to the economy by the Chancellor's policies aren't enough and they haven't been enough for the past three years.
Let's go through the budget itself. A positive thing is a cut of corporate taxes to 20% (the main rate) in 2015, which will present a total decrease of 8 percentage points (from 28% in 2010) in just 5 years. A brave and commendable policy that the businesses will welcome.
I'm particularly happy to see employer's national insurance bills cut by £2000 for every company, which will hopefully present an even stronger boost to employment. Furthermore, this move will take out 450,000 micro businesses out of the Employer's NIC altogether. I have proposed in my paper for the ASI "Unburdening Enterprise" a complete abolishment of the Employer's NIC, however this is a move in a positive direction, particularly with respect to those businesses who are taken out of the system.
What the Chancellor failed to do is to reverse the 5.6% increase in business rates which still present a significant cost for businesses, and has failed to overhaul the regulatory system and the tribunal claims. Without a complete pledge to focus on enhancing competition, improving productivity and resolving some of the largest structural issues for the British economy there will be no significant recovery and Britain will persist in this growth-less recovery and completely emulate the Japanese lost decade(s).
As for other important measures, the 3p fuel duty rise was scrapped, together with a 3p rise in beer duty (this has actually been cut by 1p). Budget cuts of 1% have been announced for most government departments in the next two years (with schools and the NHS being exempt from this), while the 1% cap on public sector pay was extended to 2015/2016. There is also a long term infrastructure program announced that is prepared to give an extra £15bn for new road, rail and construction programs by 2020, and a range of other baked and half-baked solutions aimed at some sort of a short term boost, with questionable outcomes. With such schemes the government is still picking winners and favourable industries, while spending and borrowing are still rising (still no sign of a proper fiscal consolidation).
The Bank of England was called to do more monetary activism to help the real economy, but the 2% inflation target remained intact. However, it has given hints that the BoE should focus more on growth and employment figures as well as inflation (so closer to the FED model, I think). Anyway, market monetarists probably won't be too happy, but at least the interest rates are kept credibly low, with the dubious funding for lending scheme scheduled to carry on.
Now for the really problematic policies. The most worrying one is the Help to Buy scheme. This is the idea to issue taxpayer guarantees to risky mortgages in order to boost mortgage lending and base the recovery on the housing market. Here is Alistair Heath's comment:
"Help to buy is made up of two schemes – an “equity loan” where the government lends buyers who put in a five per cent deposit up to 20 per cent of the value of a new build home and a “mortgage guarantee” where lenders will be incentivised to make more mortgages available, with the government shouldering a vast amount of risk. Both these policies are absurd and will merely push prices up, while encouraging people to take on excessive risks."
This sounds painfully close to Krugman's suggestions to Alan Greenspan in 2002 to initiate a housing bubble to offset the NASDAQ bubble. I am very surprised that the policymakers have so quickly forgotten the lessons from the 2008 mortgage market collapse. These types of guarantees is exactly what Fanny and Freddie were doing in the US in the past decade and what has caused an never-before seen bubble on the mortgage market. Not to mention the consequential artificial demand created for mortgages, upon which a whole range of financial products were being built. A disaster was looming. And with a similar scheme (just like with credit easing), the Chancellor is doing the opposite of what he is supposed to; instead of reforming Britain and enabling a new sustainable growth model, he is building the recovery (or what he hopes to be a recovery) on the worse possible incentive for a short term growth boost. Too much politics, too little economics.