Buccaneering Britain

“The absence of productivity growth in the seven years since 2007 is unprecedented in the post-war period,” said the ONS after its figures showed yet another fall in productivity.

Whichever way you measure it, it’s rubbish.

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It’s not only rubbish when compared to past performance, it’s pretty bad when compared to most of the other G7 economies. We closed the gap during the 1990s and 2000s only to see it open up again after the recession.

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Chart via IFS

LSE’s Centre for Economic Performance published a pre-election briefing on productivity a couple of weeks ago. Among its conclusions:

UK GDP per hour is currently around 17% below the G7 average. This is due to low investment especially in infrastructure and innovation, poor management and weak intermediate skills.

This chart, taken from the CEP report, shows that, while R&D investment has risen in Germany, France and the US, it has been falling steadily in the UK over the past couple of decades.

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Relative to the size of its economy,the UK’s R&D spending is now well below the EU average.

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Chart via ONS

We British like to think of ourselves as a creative nation but according to Eurostat’s innovation index, which measures innovation in a number of areas, the UK is now a follower not a leader.

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Not only that but its performance has lagged behind when compared to others in the follower group.

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Growth performance of Ireland (1.0%), Belgium (0.9%) and the UK (0.5%) is well below that of the EU and their relative performance has worsened over time.

In other words, mid-table in the second division, in danger of sliding towards the relegation zone.

Does this mean that our scientists are unproductive too? Far from it. A BIS report in 2013 found that the UK research performs extremely well when compared with other countries.

While the UK represents 0.9% of global population, 3.2% of R&D expenditure, and 4.1% of researchers, it accounts for 9.5% of downloads, 11.6% of citations and 15.9% of the world’s most highly-cited articles (see Figure 1.1A).

In other words, despite being a small country that doesn’t spend much on R&D, the UK produces world-class research. As the report says:

The UK is a highly productive research nation.

The trouble is, not much of it finds its way into the development of things which might boost the rest of the country’s productivity. As Helen Miller of the IFS remarked:

There is also a weakness in the extent to which science is commercialised and translated into new products and services.

As Ethan Mollick said, innovation requires both innovators and suits. Good managers are crucial to innovative and knowledge intensive industries. Without a supporting business infrastructure, there is nowhere for good ideas to go.

Of course, R&D and innovation aren’t the only factor affecting productivity growth but when you look at it alongside the fall in training provision and general business investment you start to see a pattern.

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Organisations have been doing less of the sort of things that improve productivity and this has been going on for some time.

Coincidence? Not according to Andrew Smithers. This is exactly what senior business executives have been rewarded for doing, he says:

A major cause of the decline in investment in recent years that has fed through more recently to falling productivity has been the change in the way senior executives are paid. The massive jump in their remuneration is largely due to the rise in incentive payments that are linked to short-term changes in profits and share prices. As such, management now has a much greater incentive than before to run companies in ways that will enhance these measures in the short term, even though the price is lower long-term investment.

Crucially, underinvestment enables companies to gain market share in the short term, as their consequent lower costs allow them to reduce their prices while maintaining the same margins and thus undercut their competitors.

In other words, if it’s bonuses based on the short-term share price you’re after, it actually pays to cut investment. If that screws the organisation in the long run, who cares, you’ll be long gone.

Because companies usually have long life spans, we might expect them to take a more considered approach. However, chief executives can rationally expect only to be in office for a few years. The change in incentives has therefore shifted the balance of decisions away from the longer-term interests of companies to the shorter-term interests of management. The result has been a sharp decline in investment, an increased drive for higher margins and a preference for adding labour rather than capital equipment in response to rising demand. These preferences naturally results in weak labour productivity.

Falling investment and its consequence, low productivity, suggests that management in the UK has become more short-termist. Given what we know about pay and reward, it’s likely that remuneration played at least some part in that. So far, there are few signs of any significant change.

Earlier this week, David Cameron described Britain as a buccaneering country. Buccaneers attacked when they saw rich pickings, grabbed as much as they could and then made a quick getaway. Maybe he’s right.

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NHS: The elephant in the public spending room

Yesterday’s FT headline announced that the NHS has a bigger hole in its finances than we thought because it hasn’t made the efficiency savings the politicians were banking on.

The National Health Service is facing an even bigger financial “black hole” than politicians and health leaders have acknowledged, following a sharp fall in productivity revealed in an analysis of official data for the Financial Times.
The research, carried out by the Health Foundation, an independent think-tank, shows that despite an inflation-protected budget, hospital productivity tumbled from 2012 as the NHS prepared for, then implemented, a contentious structural shake-up that stripped out layers of management and handed budget control to clinicians.

The Health Foundation report shows that, after an initial increase in hospital productivity in the early years of the Coalition, it then fell again in subsequent years.

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This is more or less in line with what the ONS figures showed for the wider NHS earlier this year. (See previous post.)

A report from the King’s Fund last month showed that the Coalition made more cuts to NHS budgets than it initially planned in its early years, only to increase spending again towards the end of its period in office.

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Those early years saw NHS productivity increase at a faster rate than anything seen in the last couple of decades.

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This isn’t really surprising. In an organisation that has had regular budget increases for years, it is relatively easy to spot some quick efficiency savings. The NHS, whose workers thrive on dealing with emergencies, proved to be good at finding emergency cost savings.

The difficult part of any attempt to improve productivity is sustaining the momentum in the second and third year, once the quick wins have all been spotted. In many organisations, public and private, the energy and enthusiasm starts to run out.

At the same time, the health service had to deal with a reorganisation which was massive even by previous NHS standards. It will be some time before the full cost of the Lansley reforms is assessed but restructures always divert attention away from the day-to-day. When jobs are under threat and new ones are up for grabs, people focus on positioning themselves and securing their future. That’s the same in any organisation. An earlier King’s Fund report remarked that the first part of the last parliament was taken up with understanding and implementing the reforms while the second part was taken up with limiting their damage.

As if that wasn’t enough, the NHS found itself facing rising staff costs. Was that because it breached its pay freeze? No such luck, might be the response of some NHS staff. In fact, although permanent staffing levels increased slightly, the amount spent on permanent staff fell in the year to March 2014. The rise in costs is accounted for by the extra £1 billion spent on temporary staff.

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The Health Foundation comments:

[I]t is clear that the service is under significant strain and the finances of NHS hospitals have deteriorated very rapidly.

The reasons for this are very clear from our analysis. Hospital operating costs have been growing at a faster rate than their income. The key driver of rising operating costs is staff costs and, in particular, the rapid rise in spending on temporary staff. One outcome of Sir Robert Francis’s report on the scandal of poor care standards at Mid Staffordshire has been a sharp rise in the number of nurses employed in hospitals. This has increased the unit cost of providing an episode of care.

Few would argue that having more nurses is not a Good Thing but it comes at a price.

If anyone is in any doubt about the importance of all this, take a quick look at the OBR’s long-term spending projections. I said last week that the deficit was a productivity thing and nowhere is that more true than in the health service.

According to the OBR’s forecasts, an NHS productivity increase of 2.2 percent per year would keep health spending at a constant proportion of GDP for the near future. Anything less would see health costs increase faster than the economy grows, meaning that health spending would take up an ever larger slice of our national income and our tax revenues.

Michael O’Connor has helpfully put the OBR’s low NHS productivity scenario, an annual 1 percent increase, on a chart with some of the other variables it considers.


Low heath care productivity growth will have a far greater impact on the public deficit than immigration or demographics. You wouldn’t think so from the amount of media coverage though.

As this Health Foundation projection shows, even the recent average productivity growth of 1.5 percent per year would see health spending needing to rise at 2.9 percent per year, so more than forecast GDP growth, or else a big funding gap opening up by the end of the next decade.

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It is, though, very unlikely that the NHS can sustain annual productivity increases of 2.2 percent over a long period. It has never come anywhere near that in the past. The Health Foundation concludes:

Our analysis of the efficiency and productivity performance of the NHS over recent years suggests that this will be a very substantial challenge.

[W]hile it is relatively easy to identify the opportunity, our analysis confirms that the NHS – like most health care systems – has struggled to make progress on tackling variation
in productivity.

If NHS productivity matched the estimate of the whole-economy trend rate of productivity growth (2.2% a year), public spending on health as a share of GDP could remain broadly constant and meet projected pressures. However, there is no evidence that productivity at this rate could be sustained in the medium term.

Long-term productivity improvements of more than 2.2 percent across entire service sectors are rare (see Table B of this Bank of England report). KPMG reckoned that private service sector productivity in the UK only increased by 2 percent per year in the decade before the recession.

Annual productivity increases are a big ask. We are not talking about 2.2 percent next year or even for the next five. To stop health spending outstripping GDP would require productivity increases at that level every year for the next fifteen and probably beyond. The occasional heroic 3.5 percent wouldn’t do it if it then fell back to below 1 percent the next year.

Next to pensions, the NHS is the largest proportion of public spending and the biggest chunk of public service spending by a long way. What happens in the NHS is therefore far more significant for the public finances than immigration, unemployment benefits or any of the other subjects that get a lot more air time.

Based on past performance and the pressures facing the NHS, it’s difficult to see it making productivity improvements of more than 1.5 percent per year over the next decade or so, which means it will either take up an ever greater share of tax revenues or it will have to stop doing so much for free.

At the moment, though, politicians are keeping quiet about this. They make glib statements about productivity improvements and talk about the increasing NHS deficits as though they are a temporary problem brought on by something the other lot did. What sort of health service we want and how much we are prepared to pay for it is one of the most important decisions we need to make in the next five years. Going by the level of discussion in the election campaign, though, you wouldn’t know it.

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Don’t panic, Britain is not becoming ungovernable

The reaction to Thursday’s leadership debate was far more entertaining than the programme itself, as politicians and the commentariat struggled to come to terms with the sight of seven party leaders slugging it out on TV. Frustratingly, no-one could work out who had won so everyone claimed victory.

The trouble is, our political system has been built on the assumption that one of two major parties will get a working majority. The anxiety of the week between the 2010 election and the emergence of the Coalition showed that the UK had no idea how to do multi party politics. Judging by this week’s reaction to the TV debate and the desperate search to declare a winner, it still doesn’t. During the AV referendum, a friend of mine insisted that changing the electoral system would be stupid as there has the be a winner in every race. I tried to point out that politics isn’t actually a race. But some metaphors are so powerful and long standing that people find it hard to accept they are metaphors. If we must understand elections as races, in the next one, all the contestants will collapse wheezing before reaching the finishing line.

For some last week’s debate was a game changer for others a mess. Some commentators seemed to be in denial, so they wrote the same two party stuff that they have been writing for decades. Others warned of chaos and worse. Five years ago, Britain was ‘going bankrupt’. Now, apparently, it’s becoming ungovernable.

In fact, British politics has been changing for years it’s just that, in this election, the changes have now become too big to ignore. All that happened on Thursday night was that a lot more people noticed. 

Shortly after the 2010 election, the Institute of Public Policy Research (IPPR) published a report on the slow death of the First Past the Post (FPTP) system. In 1951, the Conservative and Labour parties between them got 97 percent of the votes cast. By the last election, their share was down to 65 percent.

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For many years, though, this didn’t matter. The features of the electoral system meant that, even as their share of the vote fell, the two main parties could still win comfortable working majorities and the occasional landslide. British governments still looked like they did in the 1950s, even though the underlying numbers were changing.

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Source: Guardian

This went on until the last election when the decline in two party support became so severe that neither could get a majority of seats. Under FPTP, a minority of voters can give a party a healthy majority, provided those voters are in the right places. But even under FPTP there comes a point when that is no longer possible. Once your vote sinks to around a third, the maths start to work against you. That is where our two main parties now find themselves stuck. The old tribal identities which delivered big majorities have weakened and the once powerful vote-harvesting party machines have withered. I’m reminded of Charles Handy’s frog that doesn’t notice the water heating up and eventually allows itself to be boiled to death.

There are a couple of interesting sub-plots to all of this. One is the halving of the number of of straight Tory-Labour marginals since the 1950s, which means that a swing away from one party is less likely to deliver seats to the other.

The second is the strange death of Conservative Scotland. In 1950, Scotland was more Tory than the rest of the UK. Nowadays, the Scottish Tory is on the verge of extinction.


Source: Nick Pearce, IPPR

As the IPPR’s Nick Pearce explains, there are a number of reasons for this and it’s not all Margaret Thatcher’s fault. Nevertheless, it is unlikely to be reversed in the near future. It might soon be followed by the strange death of Labour Scotland, although it’s still a bit early to read the last rites.

All of which means that neither main party is likely to get a majority on 7 May and, even if one of them does, it will be wafer thin and will probably be destroyed by by-elections before the five years is up.

But talk of Britain becoming ungovernable is pure hyperbole. Lots of countries have multi party systems and take such things in their stride. As anyone who has watched Borgen or The Killing will know, coalitions are just part of everyday politics in some parts of the world.

The UK is a stable, well governed society with a high level of political legitimacy and a general acceptance of the rule of law. That’s the main reason why it has some of the lowest borrowing costs in the world. Other countries have cultural, regional, religious and linguistic divisions which are far more bitter than anything we have, yet they manage them within their political system. Just because the British seem no longer inclined to elect a majority government, even under a system that rigs the contest in favour of such an outcome, it doesn’t mean that the country is falling apart. Most other countries in Europe have had coalitions for decades. If Britain is becoming ungovernable then so are Sweden and Switzerland.

We need to evolve new systems and processes to manage what looks like it will become a regular feature. We’ve had hung councils for some years now. We’ll have to learn to live with hung parliaments too. The fragmentation of party politics won’t make Britain ungovernable. Politicians will just have to find different ways of governing.

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The decline in training: Are migrants giving employers a free ride?

At the Resolution Foundation’s pay event last week, someone asked a question about immigration. Alison Wolf was leaving but, just as she was on her way out she remarked that, while immigration might not have had an impact on wages, it has reduced the amount of training given by employers.

Well you can’t leave a comment like that hanging so I had a brief Twitter conversation with her afterwards to make sure that I’d heard her correctly. I had. There was, she said, a huge drop in employer training well before the crash and that a link to immigration is consistent with the evidence though difficult to prove with the data we have.

I decided to do a bit of digging. There has indeed been a drop in training provision which started sometime around the middle of the last decade. As this LLAKES report found, since the mid 2000s, there has been a steady fall in the proportion of workers receiving training in the last 13 weeks, 4 weeks and 1 week.

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Consistent with this, per capita real terms training investment has fallen by around a seventh:

The best data source for cost indicators is the Employer Skills Survey, which estimates that total employer investment in training in England was £33.3 bn in 2005, and £40.5 bn in 2011. Once inflation is factored in, this represents just a 4% increase, and since the workforce expanded during the interval it represents a real terms cut of 14.5% in training investment per worker.

A UKCES report in 2013 found that the decline in training started well before the downturn. It pointed out that, as well as the participation rate falling, even those who were given training spent less time doing it.

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The recent UKCES Growth Through People report found that training had declined for all occupational groups since the mid 2000s. The fall was less sharp for the Labour group of occupations (process, plant and machine operatives, and elementary occupations) though it started from an already low base.

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At around the same time that employer training provision began to fall, there was also a rise in immigration. It is well-known that there was a surge in immigration after 2004 when the Eastern European countries joined the EU but figures from the House of Commons migration briefing published in February show that migration from the EU15 also rose after 2005. Immigration had also been rising steadily for the previous five years.

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The decline in training occurred over a similar period to the rise in immigration so it is possible there might be a link. There is something else to consider here though.

At about the same time, the labour force participation rate of the over 50s began to rise too. According to Ernst and Young, the increasing state pension age and the squeeze on future pension income has forced a lot more people to keep working. This, say EY, together with immigration, has been the main reason for the growth of the labour supply.

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Migrants and the over 50s have something in common. They have already acquired skills and experience of the workplace. The Migration Advisory Committee found that migrants, even in low skilled occupations, are more likely to be over-qualified for their jobs than natives. In other words, like the over 50s, to some extent they come to employers ready-trained.

I’m reminded of a conversation I had with a senior executive a few years ago who remarked, “We are drinking from wells that other people have dug.” Whether those wells were dug decades ago in the UK or more recently elsewhere in the world, UK employers are able to freeride on training that has been paid for by someone else.

But this is all circumstantial. Just because some lines on graphs go in roughly the same direction it doesn’t prove cause and effect. The decline in training might be caused by something else, or may simply another symptom of wider falling levels of investment. Or it might just be a coincidence. There is no conclusive evidence that employers are cutting back on training because they have a steady supply of well-trained people. It might look that way but there is no smoking gun. Unless, of course, you know different.

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This recovery is still weak

Great news, the economy grew by 2.8 percent last year. It’s great news because it’s better than the 2.6 percent previously forecast and better than anything we’ve seen since 2006.

Like all these things, though, what you mean by good depends on where you start from. Compared to previous post-recession recoveries, 2.8 percent is rubbish.

GDP Growth since 1948

Source: ONS, OBR

In the past, we have relied on a few years of 4 percent or more to make up for lost ground. This time, we have a lot more ground to make up but growth rates refuse to touch 3 percent and, according to the OBR’s projections, will not do so for the rest of this decade. In other words, that was it. 2014 was your post recession boom.

The ONS report on Economic Well-Being was released on Tuesday. It contained this chart showing per capita GDP and Net National Disposable Income (NNDI) per head since the recession. NNDI strips out depreciation and dividends paid to foreigners.

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In other words, then, when you look at the aspects of GDP that contribute to the well-being of people in the UK, there hasn’t been much growth at all.

Once again, to take a longer perspective, Ben Chu helpfully put the figures for the past decade or so onto this chart.

CBcY3FxWsAAT3tL This shows how far we fell and how long it is taking us to come back.

How far the government is to blame for this is a question economists and historians will pore over for decades. A majority of the economists surveyed by the Centre for Macroeconomics think the government’s spending cuts caused a drag on GDP growth. So does the OBR. While its estimates are fairly conservative, others blame austerity policies for 85 percent of the shortfall between where we are now and the OBR’s 2010 forecast.

That said, it’s unfair to blame the sluggish economy entirely on Coalition policies. For most advanced economies the recovery has been slower this time than in previous recessions. Even in the US which, apart from Canada, has grown faster than the other G7 economies, the recovery has been slow. American commentators describe as dismal rates of growth that look enviable to us but compared to previous recoveries they are.

Perhaps the more important question, though, is this. If cuts acted as a drag on GDP growth in the last parliament, what will even bigger cuts do in the next one? US growth and world trade seem to be slowing down and the OBR forecasts for the UK economy suggest continuing slow growth here too. Eight years after the crash, the recovery is still weak and there are no signs of it gathering any more speed. Taking even bigger lumps out of public services is likely to make things worse.

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The deficit: It’s a productivity thing

The Resolution Foundation’s chief executive, Gavin Kelly, remarked last week:

All parties are framing the deficit as a fiscal choice. They have said very little about productivity.

LSE’s John Van Reenen said something similar in his review of the budget:

It is surprising and depressing that the Chancellor neither mentioned the productivity problem nor did anything to address it.

As did the FT’s Martin Wolf:

[I]t is misleading to view the main challenge as fiscal. It has also become clearer that the crisis both revealed and caused structural weaknesses that the government has neither recognised nor addressed. The opposition Labour party shows no sign of recognising the weaknesses either. What are they? Simply, the economy is “ex-growth” — underlying growth has stopped. Against that background, the aim enunciated by the chancellor “for Britain to become the most prosperous major economy in the world” is absurd. Here are three indicators of the extent to which the economy has gone ex-growth: real gross domestic product per head at the end of 2014 was much the same as at the end of 2006; real GDP per head at the end of 2014 was about 16 per cent below what it would have been if pre-crisis trends had continued; and GDP per hour was about 15 per cent below the pre-crisis trend.

The link between productivity and the UK’s fiscal problems is neatly illustrated on these 3 charts.


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Source: LSE Centre for Economic Performance


GDP per capita

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Source: LSE Centre for Economic Performance


Government income and expenditure

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Source: ONS Longer-term trends – Public Sector Finance

In each recession, productivity and per capita GDP fell, and a gap opened up between government income and expenditure. After each recession, the growth which followed meant that the economy got back to where it would have been had the downturn not happened. Until now, that is. The fall after 2007 was so great that a big gap has opened up between where we are now and where we might have expected to be given past post-recession trends. Productivity is flatlining so wage growth is slow. This means low tax revenues and continued reliance on in-work benefits, making the gap between government income and expenditure very difficult to close.

Adam Corlett of the Resolution Foundation shows the impact different productivity scenarios would have on each of the main parties’ spending plans. (The figures have changed slightly since the budget but the principle still stands.) Under the OBR’s most optimistic productivity forecast, even the Conservatives’ ambitious deficit targets could be achieved without any further spending cuts. Under the OBR’s most pessimistic scenario, even Labour’s slower deficit reduction plans would be blown away by poor productivity growth.

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In other words, if productivity falls short of the OBR’s central forecast, we’re in serious trouble.

As a recent ONS report showed, productivity has fallen short by comparison with previous decades and with other major economies.

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Source: ONS International Comparisons of Productivity

Last week, the Economist quipped that the French could take a day off every week and still be more productive than the British:

It might be good for some firms but low wages and low productivity don’t do much for the public finances. As the Economist concludes:

The country is running up against the limits of what can be achieved simply by boosting employment. With the recovery nearly complete, the next task for the island of cheap workers is to work out how to become an island of rich ones.

Without productivity and wage growth, we are looking at significant tax increases or else the dismantling of some parts of the state. The size of the next government’s spending dilemma depends on how far productivity increases over the next 5 years.

In its Economic and fiscal outlook, the OBR says (my emphasis):


We continue to assume that productivity growth will pick up slowly to more normal rates, but that remains the most important and uncertain judgement in our forecast.

If, as some people fear, the OBR’s forecasts are on the optimistic side, whoever wins on 7 May will find themselves with an even bigger fiscal headache than they thought.

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The 2019 deficit target is still a big ask

Despite the usual post budget hullabaloo, the only thing remarkable about Wednesday’s announcements was just how little the overall picture has changed. As Gemma Tetlow of the IFS commented, when it comes to tax and spending the giveaways are mostly matched by the takeaways.

It’s a similar story for the wider economy. Here’s the OBR’s opening statement:

In the relatively short period since our last forecast in December, there have been a number of developments affecting prospects for the UK economy and public finances both positively and negatively. These include a further big fall in oil prices, an unexpectedly large increase in net inward migration, further falls in market interest rates, another disappointing quarter for productivity growth, downward revisions to estimates of economic growth in 2014 and downward revisions to the outlook for the world economy. These have had a relatively modest net effect on our forecasts for real GDP growth and the public finances.

Some good stuff happened and some bad stuff happened to cancel it out. Like the chancellor, the economy giveth and it taketh away. The underlying position of the public finances is pretty much unchanged.

The only major difference between this budget and the last autumn statement is the Chancellor’s decision not to go for a £23 billion surplus in the last year of the decade. Given that he only sprang that idea on us in December, reversing it doesn’t change what we already knew from this time last year. (See yesterday’s post.)

Although the government’s spending plans imply an easing off in the last year of the next parliament, the cuts needed to eliminate the deficit in 2019 are still as severe as ever. We are still looking at a reduction in public service spending of nearly £40 billion after this year and even more for those departments outside the ring-fence.

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Source: Soumaya Keynes, IFS.

The squeeze would come in the middle years of the next parliament and would, says the OBR, require bigger cuts to day-to-day public service spending (Resource DEL) than anything we have seen so far.

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When it comes to spending cuts, then, nothing has changed. The chancellor hasn’t eased up on austerity, he has just eased up on the additional austerity he announced in December. Eliminating the deficit by 2019 is still as big a task as it ever was. Even before the additional targets announced in December, hitting the deficit target just by cutting public services looked unlikely. As Giles said, after leaving his job with Vince Cable:

For my last few months I asked every friendly expert I could meet: do you think the figures in the latest OBR report that suggest there will be less than £300bn of RDEL spending in 2018 are credible and achievable? I never met anyone who would say yes. Mostly they looked on me as some sort of naif. I remain slightly confused at why the OBR itself doesn’t say this.

And as IFS Director Paul Johnson remarked after the 2014 budget:

It is…a Budget which leaves us with as little sense as we had before of quite how the very large public spending cuts still in the pipeline will actually be delivered.

The “rollercoaster” promise to increase spending again in the last year of the next parliament is neither here nor there. With the cuts that would be needed in the previous years, some public services would simply cease to exist by 2020. The extra spending would ease the pressure on those left standing but by then the damage will have been done.

The numbers may change slightly but the dilemma remains the same. No government will be able to eliminate the deficit without cutting public service spending or raising taxes. Either taxes go up, or government borrowing continues into the next decade, or some public services disappear. To pretend otherwise is still as much the politics of La La Land as it was last year.

Public Spending Venn 2015 - Plain

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