December 5, 2012 8:32 pm

Osborne walks a tightrope on deficit

At least chancellor has stopped digging the hole he inherited

Barely a week has passed since George Osborne was being cheered in the House of Commons for securing the appointment of Mark Carney as the next Bank of England governor. The chancellor’s visit to the chamber on Wednesday, to unveil his Autumn Statement, was an altogether more sombre occasion.

Mr Osborne put a brave face on the grim news he had to impart. He repeatedly insisted that the British economy was healing, but the road was long and hard.

The figures he revealed, however, tell a less reassuring story. Halfway through a parliament in which Mr Osborne hoped to restore the nation’s finances, the British economy has stagnated. It is expected to shrink 0.1 per cent this year against the 0.8 per cent growth expected by the Office for Budget Responsibility just months ago. Nor is the longer-term picture more encouraging. The estimates for growth in future years – up to 2018 – continue to slide. The UK faces a lost decade.

Back in 2010, the FT acknowledged that Mr Osborne’s deficit reduction programme was a gamble. The calculation was that reining in the state’s finances would give the private sector the confidence it needed to invest and expand. While this has to some extent happened in the labour market, it has failed to feed through to the overall growth rate of the economy. This has made the hole in the public finances look even deeper than it did.

The government’s critics blame its fiscal strategy. But the OBR attributes faltering growth to the recession in the eurozone. The conclusion is inescapable: if the chancellor’s original policy was a gamble, slowing deficit reduction and placing trust in twitchy bond markets to stay calm would put hard-won credibility at risk. The persistent euro crisis would have hurt the UK whatever the government’s actions. The consequences of less fiscal discipline, were things to go wrong, would be extremely hard to deal with.

The chancellor’s plan was always premised on monetary expansion keeping the economy ticking over while the state retreated. That this has not happened is primarily a failure of monetary and banking policy rather than the fiscal stance.

One would have expected Mr Osborne to address more forcefully the lack of lending to the UK economy. His statement was another missed opportunity to do so.

The arrival of a new BoE governor may well be an opportunity to discuss whether the central bank’s mandate is right for the economic challenge the country faces. On lending, the government’s “Funding for Lending” strategy falls short of what is needed. As the BoE has warned in recent weeks, further restructuring and recapitalisation of UK banks may be needed to restore the flow of credit to fuel growth.

The best that can be said for the Autumn Statement is that the chancellor has stopped digging the hole he inherited. He has rightly eschewed cutting even more deeply to make up for slipped targets, even though this means that one of his two fiscal rules has been broken. The path of deficit reduction will be extended for another year to 2018 – well into the next parliament.

Otherwise, the statement offered more bitter medicine. Mr Osborne’s determination to stay the course confined him to rejigging priorities within the overall spending envelope the government has set.

But he could have been more radical. While the government has belatedly recognised the need to restore capital spending, the £5bn of extra investment promised for roads and schools, though welcome, is small beer.

There were some business-friendly measures. Companies will cheer the unexpected reduction in corporation tax to 21 per cent. The tenfold increase in capital allowances could help to unlock some much needed corporate investment. Mr Osborne sought to balance further welfare cuts with a reduction in the amount of money high earners can put tax-free in pension funds and a broader crackdown on tax evasion. The politics of all this is more important than the economics.

The chancellor showed great boldness in the appointment of Mr Carney. His Autumn Statement would have benefited from a little more of the same spirit.

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