Tuesday, October 26, 2010

Output growth in the third quarter of this year, at 0.8%, was faster than many commentators expected. This is good news, clearly.

It is unlikely, however, that such a rate of growth could be sustained into the future - even in the absence of tough government budget cuts. While the latest data give some encouragement that the economy is stronger than we thought, the prospects for continued growth over the next couple of years remain very modest.

Monday, October 25, 2010

A few months ago, I reported the results of a simple forecasting model that I tried out on UK data, looking ahead over the next year or so. It's time for an update. There is good news and bad news: the model is no longer predicting a nosedive for late 2011. However it does predict extremely sluggish growth, barely above zero in most months and dipping slightly below zero on occasion.

This is not the type of model that allows consideration to be taken of policy announcements - it's simply based on the time series of a single variable. What we know about the likely trajectory of the economy, even in the absence of policy shifts that are themselves deflationary, is that the scope for growth is very limited.

Wednesday, October 20, 2010

The cuts to public spending announced in today's spending review were well heralded in advance. That said, the expectations management of the government has not been terribly sophisticated - there is no room for celebration that the cuts have turned out to be less severe than feared.

The cuts amount to £81 billion per year by 2014-15. This is in addition to £29 billion additional tax revenues that the government hopes to bring in from policies announced earlier. This will much more than wipe out the structural deficit (on any reasonable calculation of what the structural deficit is), and suggests that the government is seeking to leave itself scope for tax cuts later in the parliament. Unfortunately the economy needs the breaks (and certainly not the brakes) now, not in four years time.

The phasing of the cuts is gradual - with around £20 billion extra being taken off the total spend in each of the next four years. In view of the current fragility of the economy a more phased ramping up of the cuts would likely have been prudent. It is not clear that the patient can easily stomach the medicine in the immediate future - we should now expect growth (if indeed there is to be any growth) to be very sluggish indeed over the medium term.

Since cuts of around £80 billion were heralded in the emergency budget, none of the above is terribly new. What is new is the detail about where the cuts will come from. Of the really big spending departments, the hardest hit are to be local government and (as part of the Business, Innovation and Skills budget) the universities. For the latter, the increase in tuition fees proposed by last week's Browne report serves as a useful stealth tax. For the former, the cut will have to be managed by people outside central government. Easy targets, then, that allow the policy makers to say there is a plan when in fact the plan is to let others work out a plan.

Health spending has been protected, as (largely) has education (below the tertiary level). These would, of course, have been tough targets.

A total of almost half a million public sector jobs are set to disappear. The government hopes that the private sector will grow to compensate for this, and cites the forecasts of the Office for Budget Responsibility as evidence. It will be interesting to see if the OBR continues to be so sanguine as time unfolds. I see little reason to share their optimism.

Thursday, October 14, 2010

After rising somewhat in August, consumer confidence in September continued its downward trajectory. This should be seen as further evidence to suggest that caution is needed before cutting back too fast on public spending.

Monday, October 11, 2010

The plethora of stories about the future of higher education funding in the UK is multiplying fast, as we await publication of the Browne reivew on 12 October. Over the weekend, it appeared that the interest rate charged on loans would vary positively with graduates' incomes. The media today are full of a somewhat simpler proposal - namely that all but those on the lowest incomes would pay a flat rate of interest.

If, as seems likely, the Browne review recommends either the removal of the cap on tuition fees or a substantial rise in the cap, then charging a flat interest rate equal to the market interest rate would be sensible. Removing the cap (or raising it substantially) gives universities the right to set their own fees for undergraduates - and, since these fees are currently paid upfront by the government with students repaying them using a subsidised loan, this has implications for government expenditure. In effect, the co-existence of a free market in tuition fees and subsidised interest rates means that government would cede control of its own spending. Given its stance on the budget deficit, the current government is hardly likely to do that.

If the cap is removed (or substantially raised) and market interest rates are charged on student loans, the problem is largely solved. To be sure, the government would need to find the money to pay the fees upfront. But, with market interest rates being charged, it could pass this problem on to the private sector. Government could bundle together individual students' debt, and sell packages of the debt to the banks. It needs to do so at a discount in order to make the package attractive, but, with a real interest rate, the discount would need to be much smaller than it is at present.

Sunday, October 10, 2010

In 10 days time, we will know the outcome of the comprehensive spending review. Cuts of the order of 25% have been mooted as the government attempts to tackle its budget deficit. It is not clear where the 25% figure comes from - government spending is currently running at around £660 billion per year, and a 25% cut in this would more than wipe out the entire deficit - not just that part of the deficit that is 'structural'.

Around a half of the deficit is due to the shortfall in economic growth over the years of recession and early recovery. During downturns, the government's revenues from tax automatically fall, and government spending rises - both because benefit payments increase and because discretionary policies are put in place to stimulate the ailing economy. This bias towards deficit in a recession is not a long term problem, and that part of the deficit that is due to such factors is not part of the 'structural' deficit that the government is aiming to cut.

It seems, therefore, that the 25% figure is a rather crude attempt at expectations management. At least, one hopes so.
The latest noises about the reform of higher education funding in the UK suggest that the government is considering a move to charge higher interest on student loans to those graduates in higher earning groups.

A side-effect of such a scheme would be that, at a certain level of income, graduates would take home less pay if they worked more. At the trigger point for the higher interest rate, working a little more would cause higher interest to be charged, presumably, on the whole of the loan, thus making the graduate worse off. This is what is sometimes called a 'poverty trap' (though the terminology is ill-suited to the case of high earning graduates).

The government is, rightly, trying to simplify the welfare system so that such poverty traps are eradicated. It would be perverse of it to introduce a poverty trap into the student funding system.

The Liberal Democrats are concerned to ensure that student funding is progressive. As I have noted elsewhere on this blog, it is, however, the progressivity of the whole tax system that matters - not the progressivity of the student loans system alone.

Monday, October 04, 2010

There have to be cuts, and, if cuts there have to be, it is as well to introduce reforms alongside them. In my blog post of 23 June this year, I suggested that a quick win would be to limit the availability of child benefit to those parents who most need it. Today's announcement that child benefit will no longer be available to those households where there is a higher rate taxpayer is therefore welcome.

Also welcome are some of the noises about welfare reform. The government's proposals in this area remain thin on detail - and the detail will matter. But one idea that has been mooted is that benefit claimants taking on a job would be allowed to keep claiming their benefit for a fixed period in addition to their earned income. This would mean that no-one could claim to be made worse off by taking on employment. The length of the fixed period matters, of course. But this would appear to be an idea with some merit.

That said, it is not a policy that should be expected to work miracles in reducing unemployment in the short term. The recovery from recession is likely to be slow, unemployment is likely to rise, and the reason for that will be that the economy's demand for labour remains weak. The welfare reform may well improve people's willingness to supply their labour when the economy is approaching capacity constraints. But that time is quite a long way ahead of us.