First posted Wednesday, 12 December 2012 – Socialist Economic Bulletin
The updated forecast may also prove to be overly optimistic. The OBR uses the UK Treasury’s model of the economy. In 2010, it forecast that investment (Gross Fixed Capital Formation) would lead the recovery, rising by 11.5% between 2010 and 2012. In fact it is the only component of GDP which has fallen over that period, down by 2.8% to the 3rd quarter of 2012.
Since the OBR was established by the Coalition government real GDP has risen by just £27bn. As SEB has previously shown that was largely a function of the momentum established by increased spending under Labour in 2009. Since Osborne’s first Autumn Statement in 2010 the economy has grown by just £8.2bn and excluding the Olympics’ effect in the 3rd quarter of it has actually contracted by £5.6bn.
Fig.2 shows the change in real GDP and its components since the OBR was established in 2010. GDP over the period rose by £27bn. All other main components of GDP also rose, although the rise in household consumption limped to an increase of just £2.6bn. But the fall in investment has been the main brake on activity falling by £6bn over the period.
This highlights the essential fallacy of official economic models shared by the Treasury, the OBR and others. The private sector was said to respond to lower government spending by increased spending of its own. The opposite has been the case. Faced with government cuts the private sector cut back on its own investment (and pushed up government current spending in the process as poverty and underemployment rose).
Therefore the government’s insistence on continuing ‘austerity’ not only for the rest of this parliament but also out to at least 2018 will not produce a different result. Economic stagnation and ‘austerity’ are set to become embedded in the economy over the next period, for at least a decade since the recession began.
Osborne has already challenged Labour to continue and deepen the cuts well into the next parliament. But only a decisive break with Tory cuts will produce a different result. Reversing the cuts and growing the economy through investment is required. In light of the private sector strike only the state has the capacity to do that. Enacting slower, shallower cuts will produce only a somewhat less stagnant economy and both poverty and the public deficit which grow more slowly.
On the right of the Tory party John Redwood consistently argues that there are no cuts as government spending continues to rise in cash terms. Very few misrepresentations consist of a complete fiction but instead rely much more on a large distortion of the truth by disregarding key elements of it. The Redwood argument is typical.
Cash spending is rising because of three factors. It includes rising interest payments on government debt, not on services, welfare or public sector pay. Secondly, it includes increases in the numbers entitled to welfare payments because of the stagnation caused by government policy. Thirdly unchanged nominal spending includes the effects of inflation. Once inflation is taken into account real government spending is falling.
This is an important point. The process of ‘fiscal consolidation’ is frequently accounted in a cumulative way for this reason. If a benefit is frozen in cash terms (or held below the rate of inflation) over a prolonged period the effect of the cuts deepens over time as inflation continues to rise. There are a few benefits which have been cut outright and scandalously these include benefits for people with disabilities, support for childcare and the education maintenance allowance and housing benefit for poorer households.
But the overwhelming majority of cuts are based on freezes or sub-inflation rises in benefits. These have now been increasingly back-loaded to the next parliament as the table in Fig. 3 shows, taken from the Autumn Statement. Osborne’s plans increasingly rely on fiscal consolidation in the next parliament. In addition to those tabled here, there are nearly £19bn in further cuts which have already been outlined for the two further years to 2018.
If Labour is elected but does not reverse these plans it will be implementing cuts much greater in 2015/16 than the cuts that were implemented in 2011/12. The real effect of the cuts will be more than three times greater. To give one example, pegging the new Universal Credit to a rise of just 1% is expected to save £640mn in 2014/15, but to save more than £2.2bn in the two following years. Of course, this supposed saving is in reality only a measure of how much these benefits will be cut. As incomes of the poor are cut, spending is cut by an equal amount. This would otherwise circulate in the economy and largely return as government tax revenues. It is also planned that government investment will be cut even further to a level barely above the rate of depreciation.
Whichever party or combination of parties is elected in 2015 it can expect only long-term austerity and economic stagnation unless it is willing to break decisively with current failed policy.