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A Good Autumn Statement, but the Economic Future Still Hangs in the Balance

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The 2012 Autumn Statement always promised to be a difficult day for the Chancellor. We knew the OBR would revise down GDP growth forecasts. And they did. We knew that the Chancellor's two fiscal mandate rules would be under pressure as a result. And they are.

The Chancellor needed to maintain deficit reduction whilst at the same time boosting business confidence and he broadly succeeded, especially with the surprise reduction in Corporation Tax.

In a fiscally neutral Autumn Statement he announced a whole raft of measures, mainly good but some bad.

The good news was that the Chancellor introduced four key changes which the Institute of Directors (IoD) had called for in our Autumn Statement submission: shifting money from Whitehall budgets to infrastructure spending, changing capital allowances to encourage firms to spend, supporting shale gas to deliver low-cost, domestically-sourced energy and, of course, the Corporation Tax cut.

While he did not introduce full-scale regional pay, he did open the door a crack by announcing the introduction of localised pay in schools. The disparities between public sector and private sector pay are having a serious impact on private sector recruitment, particularly outside London and the South East, so progress towards an end to national pay bargaining is also welcome.

It wasn't a perfect set of policies. The most notable error was cutting further into the remaining tax reliefs on pension contributions. As easy as it is for some to shout that this will only affect the better off, it must be seen as part of the wider pensions mess. Repeated tax grabs over decades have shattered the public's faith in the faltering pension system. Most young people don't see the point in a pension at all, as the tax man has eroded the value of such saving, while the public at large now put more into tax-free ISAs than into pensions, for good reason.

That aside, Osborne can give himself a pat on the back - the Autumn Statement was a tricky job, well done.

Of course, that doesn't let the Chancellor entirely off the hook. There are still threats to his prospects of eventual success.

Deficit reduction and economic recovery remain the two most important aims on his "to-do" list. They are also intertwined.

For readers sceptical of the need for even greater austerity, remember that between 2010-11 and 2016-17 public debt in the UK will increase by almost £600 billion to a hefty £1.5 trillion. We have long supported further and faster deficit reduction, but business leaders also recognise the political reality of Coalition politics and the inability of the Government to deliver a steeper decline in the deficit. We need growth to really deliver success in the war on the deficit.

So what are the prospects for growth?

In March 2012, the Office for Budget Responsibility (OBR) essentially forecast 1%, 2% and 3% growth over the three years to 2014. In the Autumn Statement these numbers were revised down to roughly 0%, 1%, 2% over the same period. That is a serious shift.

Despite their fading optimism for the short-term, the OBR forecasts for 2015 onwards remain stronger, with 2.7% growth forecast in 2016 and 2.8% growth in 2017. That growth is essential to the Chancellor's plans.

Of course, these numbers are little more than guesses, but they also provide a pretty clear warning.

If GDP growth doesn't accelerate after 2013, the current estimates of the public finances could be shot to pieces in the run up to the General Election in 2015. The Chancellor could very easily miss his fiscal rules in such circumstances i.e. the cyclically adjusted current budget wouldn't move to surplus and public sector debt would continue to rise as a proportion of GDP. Politically, the consequences would be almost as huge as they would be economically.

So let's be absolutely clear. It is perfectly reasonable for the OBR to assume that in the wake of many years of weak GDP performance, there should be an output gap with spare capacity in the economy, and the potential for a growth spurt as a result. Indeed, that is exactly what the OBR's latest forecasts show, with an output gap of 3.2% of GDP in 2012-13, 3.5% in 2013-14 and 3.3% in 2014-15.

Where the IoD departs with this analysis is with regard to what underpins these output gap calculations. We are more pessimistic about the underlying growth potential of the UK economy, arguing that as a result of over taxation, over regulation and over indebtedness, the potential output of the UK economy may have already fallen to 1.5% per annum or less.

Everything hinges on who is right on this number. If the OBR is correct the economy and public finances could be looking rather better in the run up to the General Election. If we are correct, the Chancellor will almost certainly miss the primary and supplementary rules which make up the so-called fiscal mandate. If that happens, the future does not look anywhere near so rosy.

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