Four things the Chancellor got right

by Ed Bowsher on 29 November 2011  |  14 comments
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George Osborne, the Chancellor of the Exchequer, announced several sensible moves in his autumn statement. But he's still constrained by the mistake he made when he took office.

I’m normally pretty negative when I write about George Osborne, so I thought I’d try and find some positive things to say about this week’s autumn statement. And, in fairness, it wasn’t hard to find some good stuff. Let’s take a look:

1. Credit easing

The government wants to encourage lending to smaller businesses. So it’s setting up the National Loan Guarantee Scheme with a £20 billion fund. 

This government loan guarantee will hopefully encourage the big banks to lend more and at a lower rate. If this guarantee works, borrowing costs for many small businesses should fall by around 20%. The government could add further cash to the fund in two years’ time. 

I’m not certain that this scheme will work, but it’s definitely worth a try.

2. Infrastructure

More spending on infrastructure makes a lot of sense. Building, say, a new port delivers a short-term boost to the economy by reducing unemployment. And it delivers a long-term boost by making it easier for UK businesses to export their goods. 

The government is going to try and persuade UK pension funds to invest £20 billion in new infrastructure projects. An excellent idea! I hope it works. 

3. Raising the pension age

Many people who are currently in their 50s will now have to work an extra year before they can receive the State Pension. 

The state pension age will now rise to 67 in 2026. Under the previous plan, that rise wasn’t due to happen until 2036. 

I can understand that many fiftysomething folk will be pretty fed up with their decision. But, sadly, I think it’s the right thing to do. Life expectancy is rising all the time, so we have to push up the retirement age to stop the cost of pension payments going through the roof. 

4.  £600 million for free schools

The Chancellor has allocated an extra £600 million for the creation of 100 new free schools in the UK. The school age population is rising so we need more school places. 

I like the idea of free schools, so I support opening more. Let's see whether the free school model can improve standards across the UK. 

Big mistake 

The sad thing is that the Chancellor could have done more in this week’s statement if he hadn’t made a big mistake in his first budget in June 2010. His deficit reduction plan was seriously flawed. 

Let me explain why. If you’re trying to cut a government’s deficit, there are two broad strategies you can follow. You can either: 

-          Go for austerity. Cut government spending and/or increase taxes. This is the ‘common sense’ solution. It’s what individuals and businesses have to do when they’re in too much debt. 

or

-          Go for growth. Increase government spending and/or cut taxes. You could also introduce other pro-growth measures. If the economy grows fast enough, rising tax revenues will help to cut the deficit. 

The problem with the ‘growth’ option is that it can cause inflation in some circumstances. There’s also the danger that a growth strategy may damage credibility in the bond markets and push up the cost of borrowing for the government. If the government’s cost of borrowing rises dramatically, the whole strategy falls apart and the deficit balloons instead of falling. 

The problem with the ‘austerity’ option is that cutbacks can crimp economic growth which reduces tax revenue. So even though the government has cut spending, the deficit can be as large as ever. 

That’s precisely what has happened over the last year. In spring 2010, UK GDP rose by 1.1% in just one quarter. Now the latest growth forecast for this year is 0.9%. This dramatic slowdown was partly caused by the government’s austerity strategy. 

If the government had instead gone for a mix of ‘growth’ and austerity’ in 2010, I’d be expecting higher economic growth for the UK in 2012. Then Osborne would have had more money to spend on things like infrastructure. 

I don’t think inflation would have been a problem because there was plenty of spare capacity in the economy, so extra demand wouldn’t have sent prices soaring. 

What about the markets? 

Then there’s the view that Osborne’s austerity strategy was the only way to maintain credibility in the bond markets. Well, I can never prove that we wouldn’t have had a bond market crisis had we followed Alistair Darling’s budget plans. But I think it was unlikely. 

That’s because we weren’t a member of the euro and we didn’t need to renew a large amount of debt via fresh bond auctions in the 2010-12 period. 

And anyway, the scary scenario is that the bond markets might still lose confidence in us. If economic growth becomes even more anaemic, you can’t completely rule out a bond market crisis next year. 

So it’s all rather depressing. At least we can take a bit of comfort from the fact that the Chancellor has got some things right. 

More:  History won’t judge this budget kindly