When the Chancellor, Philip Hammond, delivered his first set-piece fiscal event in the form of last November's Autumn Statement, there was little doubt that it marked a structural break from the fiscal policy of his predecessor, George Osborne. This is not just for reasons of personality; a change of management provides an opportunity to chuck out old practices and rules and try a new approach - and certainly anyone observing Osborne's increasingly elaborate fiscal contortions, as he struggled to meet his fiscal rules, would have had the strong sense that this was a strategy that had run its course.
Less remarked upon, but potentially significant, is the recent change of management at the Office for Budget Responsibility (OBR), the government's independent economic and fiscal forecaster. Former Deputy Governor of the Bank of England, Charlie Bean, replaced Steve Nickell as one third of the OBR's Budget Responsibility Committee at the start of the year, and is effectively now in charge of the forecast and all of the assumptions that go into it.
This means that, even though the Autumn Statement was only a little over three months ago, we could see more change than usual to the OBR's economic and fiscal forecasts this week. As with all forecasts, the OBR makes several judgement calls in deciding what it thinks will happen to business investment, employment, wages and tax receipts in the coming years - a new boss means a greater than usual probability that those assumptions could change.
The most significant potential revision is to the assumption that productivity is unaffected by lower trade flows. In its November forecast, the OBR assumed that there would no hit to productivity from reduced trade with the rest of the world. But in practice some impact is likely: the more open an economy, and the more exposed it is to competition from abroad, which forces firms to continually up their game and become more productive. With Brexit implying lower trade flows, our productivity growth is therefore likely to be lower. This is what the Bank of England assumes; Charlie Bean is likely to bring this assumption with him to the OBR - meaning a lower forecast for productivity growth from 2019 this time around. Lower productivity is likely to translate into lower growth, and lower tax receipts.
Another assumption potentially vulnerable to a revisit relates to how consumers in the UK might respond to more expensive imports post-Brexit. In November, the OBR assumed that the impact on growth of the UK becoming a more closed economy would be roughly neutral: lower export volumes would be balanced by lower imports, as UK consumers bought fewer imported goods, and switched to domestically-produced alternatives. But this may not be realistic - our import intensity (the proportion of the goods and services we consume that are imported) has, as the OBR noted in November, been rising steadily for most of the past half-century, meaning this assumption - new in the last EFO - represents a complete break from past trends. It was a bold decision on the part of the OBR to take this position; it may decide to reverse it in future forecasts. If it decided to make this change now, it would again result in a lower forecast for growth and tax receipts from 2019.
Rather counter-intuitively, the productivity forecast may be revised down in the near-term as a result of economic data released since the EFO - even though, on the surface, these data have been better than expected. Why? Because our ever-lower unemployment rate suggests that there is a bit more 'slack' in the labour market than forecasters had assumed a few months ago. This means less chance that productivity will pick up in the short term, as employers can continue to recruit new workers rather than getting more out of their existing workforces. The Bank of England revised down its forecast for productivity this year as a result of this analysis, and the OBR may well do the same. However, the growth forecast for 2017 will undoubtedly be revised up given much stronger than expected business investment and consumer spending at the end of 2016 and start of 2017.
All of the above means that the deeper picture of the long-term productive potential of the economy, and therefore the improvements we can expect in living standards and tax receipts in the coming years, is likely to look a little worse this time than last - particularly post-2019 (although of course, there is always the chance that some or all of the assumptions are not changed this time round). This would be the darker side of a forecast that, in the near-term at least, will probably be revised up - and helps to explain why Hammond is keen to build up a 'war chest' rather than spending all of the fiscal windfall he is likely to be gifted this week.
There are two lessons to take from this: first, that being motivated by achieving a given level of deficit by a certain date, as Hammond still is in spite of his relaxation of the fiscal rules, leaves the Chancellor vulnerable to fluctuations in two very large, very unpredictable numbers - the forecast for GDP, and for net public spending - both of which hinge on a plethora of assumptions that are open to challenge and change at any time. The second is that, in spite of the continued resilience of the UK consumer, the UK economy is fundamentally not in good shape, with productivity expected to continue to disappoint, and almost no significant growth in wages to bolster incomes against the coming inflation shock. Brexit is unlikely to do anything to rectify these flaws.Suggest a correction