Hammond’s Autumn Statement: the truth will out

Today’s Autumn Statement—a budget by any other name—mattered more than most. For one thing it was the first big fiscal set-piece of the new government headed by Theresa May. Budgets define priorities by backing policies with hard money. For another, the Autumn Statement was a moment of reckoning on the economic and fiscal costs of Britain’s ill-fated decision in June to leave the European Union.

Soon after becoming chancellor of the exchequer in July, Philip Hammond said that the Autumn Statement could bring a “reset” of fiscal policy. At the time this seemed to indicate a readiness to provide a budgetary stimulus to steady the economy. The continued buoyancy of consumer spending in particular since then has made such a boost unnecessary at this juncture. But Hammond has nonetheless delivered his reset, through new and more lenient fiscal rules. These will allow the Treasury to absorb the costs of Brexit through higher borrowing as well as creating some scope for giveaways.

The need for such slack was spelt out in the projections of the Office for Budgetary Responsibility (OBR), the watchdog that oversees economic and fiscal forecasting. All in all, the OBR reckons that the government will borrow £122bn more than it expected in March during the five fiscal years between 2016-17 and 2020-21. Of this, £26bn arises from deliberate policy decisions. These start modestly and are concentrated in the last two years, costing almost £10bn in 2020-21. Most of the extra borrowing—£96bn—stems from an underlying worsening in the public finances.

The main reason for this deterioration is that growth will be slower than previously expected. The economy may have been resilient until now but prospects for the next two years have dimmed. The OBR has cut its forecast for GDP growth in 2017 from 2.2 per cent to 1.4 per cent, and in 2018 from 2.1 per cent to 1.7 per cent. In each year consumer spending will rise by little more than 1 per cent, compared with almost 3 per cent this year. The pain of Brexit has been postponed rather than dispelled. Households will feel it acutely over the next two years as the falling pound pushes up inflation and squeezes real incomes.

As important, Brexit will damage potential growth. The uncertainties of Britain’s future relationship with the EU will cause firms to cancel or to reduce capital spending. By 2020, business investment will be over a tenth lower than if Britain had voted to stay in the EU. That will in turn harm productivity, the mainspring of potential growth. As a result potential output in 2021 will be 1.5 per cent lower than the OBR expected in March. If the effect of the vote on restraining migration is also taken into account output will be 2.4 per cent smaller.

Since GDP is the tax base this feeds through to the public finances. In March George Osborne envisaged a surplus of around £10bn—0.5 per cent of GDP—in both 2019-20 and 2020-21. In November, his successor expects to borrow around £20bn—1 per cent of GDP – each year.

Hammond can do this because he and May have abandoned Osborne’s main fiscal objective, to achieve an overall budgetary surplus by the end of the parliament. In its place the new chancellor has announced yet another set of rules. Instead of seeking a surplus he will aim for a structural deficit of less than 2 per cent of GDP by 2020-21. That gives Hammond some leeway if things turn out even worse than expected. Specifically, he can borrow an extra £26.5bn—1.2 per cent of GDP—in 2020-21. In addition, the goal for public sector net debt to fall each year as a share of GDP in this parliament (already broken for 2015-16) has been delayed until 2020-21.

May and Hammond may need all the leeway provided by these laxer rules to the extent they are taken at all seriously. The OBR has done its best to take into account the impact of Brexit, but the uncertainties remain large. If negotiations turn sour over the next two years the economy may take a further knock, damaging the public finances further.

The grim economic and fiscal outlook has limited Hammond’s ability to offer the crowd-pleasing measures his prime minister wanted. Most of the extra spending will be on investment projects, in particular on housing, transport infrastructure and R&D. The extra capital spending is welcome but hardly game-changing.

Before the Autumn Statement there was much chatter about possible help for people who are “just about managing,” an ill-defined group of lower-paid workers dubbed the “jams.” In the event the main measure was yet another freeze in fuel duty. The benefit-withdrawal rate on universal credit will be lowered a bit though this will take effect mainly towards the end of this parliament. This group will continue to suffer as Hammond did not lift the freeze on most working-age benefits, which will bite more as inflation rises.

Since the referendum Brexiteers have sought wherever possible to accentuate the positive. Today’s fiscal statement administers a much-needed dose of realism. The decision to leave the EU will indeed damage the economy—and present an unwelcome budgetary bill as well.