U.K.’s Iron Chancellor Should Take It Easy
The bad news never stops for U.K. Chancellor of the Exchequer George Osborne. On Dec. 5, he had to announce that economic growth this year will fall below zero and that the country’s debt will go on rising as a share of the economy even longer than he had pledged.
Osborne’s midyear budget statement, an annual set piece of Westminster’s political theater, was the moment for him to relax austerity and introduce convincing measures to stimulate the anemic levels of investment and growth that now threaten long-term damage to the economy. Unfortunately, Osborne continued to play the role of Iron Chancellor, arguing that to loosen fiscal policy now would spook markets, drive up the U.K.’s low borrowing costs and put it on “the road to ruin.”
In lieu of real change, he proposed a set of well-intentioned but ultimately insignificant policies, restricted by the need to make the package as a whole fiscally neutral. Osborne didn’t need to be so cautious.
To understand why, consider the lack of market reaction to Osborne’s statement, in which he not only revealed the dire economic growth figures -- now forecast to be minus 0.1 percent this year and a feeble 1.2 percent next -- but also confirmed that he would miss his debt-reduction target. That’s one of the targets on which market confidence in the U.K. is supposedly based. Yet yields on 10-year bonds fell slightly, not because of Osborne’s revelations but that the government will sell fewer bonds than expected.
Consider also that with the exception of the euro area, with its specific currency-related troubles, most major economies now enjoy low borrowing costs, whatever their fiscal virtue. That’s because, as the International Monetary Fund said in its most recent staff report on the U.K., “bond yields have been driven more by growth expectations than fears of a sovereign crisis.”
To his credit, Osborne did act to redirect government money in a few ways likely to produce growth. He said he would reduce the nominal rate of corporation tax to 21 percent from 24 percent in 2014 (compared with 35 percent in the U.S.). He also increased by a factor of 10 the amount of capital investment that U.K. companies can make exempt from tax each year, to 250,000 pounds ($400,000) from 25,000 pounds.
Osborne scraped together $8 billion to spend on school construction, transportation and flood defenses. He squeezed the money from further public-sector staff cuts, holding benefit increases below inflation; he also made some sharp moves on taxes, such as shrinking the amount of cash the wealthy can put into their pensions tax-free each year to a still-generous $64,000.
In addition, he set up a body to eliminate the regulatory gridlock that’s blocking development of shale gas in the U.K. and promised tax breaks for exploration, ahead of a new policy directed at increasing the U.K.’s production and use of natural gas. These are all intelligent ideas that might boost construction and employment in the near term, and growth in the longer term.
The scale of the projects, however, is too small to be significant. The Ernst & Young Item Club, an independent group that examines U.K. budgets, figured that the $8 billion infrastructure package might increase growth by 0.2 percent. It recommends a package of similar spending worth $22.5 billion.
The chancellor might also consider more idiosyncratic steps to temporarily increase demand, such as giving employers a vacation from social security payments of, say, two years, which could help job growth.
We don’t argue with Osborne’s initial decision to embrace austerity -- the hole that the banking crisis blew in the U.K.’s finances was huge. It was impossible at the time to predict with certainty how credit-rating companies and bond markets would react if the government wasn’t taking drastic action to stop the bleeding. Unlike the U.S., the U.K. doesn’t enjoy a reserve currency that makes it immune to market concerns over borrowing.
A lot has changed over the past two or three years, however, and Osborne should recognize it. The benefit of his bid for credibility is that if he sets out a clear plan to bring down debt in the medium term, markets will probably believe him and understand the need to give a modest boost to the economy as growth flatlines. In the next few months the U.K.’s chancellor should use the trust he has built to ease austerity’s grip.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.