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Gordon Brown is on thinning ice. The performance of the economy is far from a disaster. The same is true of the public finances. But, taken together, they begin to raise questions about the chancellor’s stewardship.

A slowdown in the economy in a year of high oil prices and a cooling of the overheated housing market is no surprise. Nor are mistakes in forecasting a disgrace. The Treasury’s mistake has rather been to persist with point estimates of future outcomes. No one can forecast to that degree of accuracy. The pretence that one can, abandoned by the Bank of England but not, alas, by the Treasury and most City forecasters, is charlatanism.

If the shortfalls in growth and fiscal revenue were temporary, they would barely matter. The worry is that excess capacity is less, trend productivity growth is significantly slower and fiscal buoyancy considerably smaller than the Treasury now expects. The growth of public spending is set to slow sharply. But Mr Brown may have to raise taxes, too. This is far from a golden legacy for the next prime minister, presumably Mr Brown himself.

Start, then, with the economy. The chancellor has downgraded his forecast for this year to 1¾ per cent growth, from the 3 to 3½ per cent forecast in the Budget, last March. This is partly because of revisions to the data, which pushed growth in 2004 up to 3¼ per cent from the 3 per cent expected last March. It is far more because of the sluggish rise in real domestic demand, now expected to be 1¾ per cent this year, against the March forecast of 3¼ to 3½ per cent.

It would be mad to describe this as a calamity for which the chancellor should do penitence in sackcloth and ashes. As Mr Brown himself remarked, for the fifth successive year, British growth is higher than in France, higher than in Germany, higher than in Italy, higher than in the eurozone, higher than in the European Union. The UK will register a 14th year of positive growth in 2005. A slowdown in the housing market, welcome in itself, was bound to have some such effect, particularly in a year of soaring oil prices.

The question, rather, is: what sort of rebound lies ahead? The Treasury believes the “output gap” (actual output, less trend output, as a share of the latter) will reach 1½ per cent of gross domestic product next year. Virtually everyone else believes it is far smaller: the Organisation for Economic Co-operation and Development, for example, has estimated it at 0.5 per cent this year and 0.7 per cent in 2006. The fact that inflation in the year to the fourth quarter of 2005 is now forecast by the Treasury to reach 2¼ per cent against the March forecast of 1¾ per cent, in spite of the weaker growth, reinforces the plausibility of the view that the economic slack is now quite modest.

So, too, does this year’s productivity performance, dramatically demonstrated by the chancellor’s own boast that the numbers in employment have risen by 330,000, in a year of slowing growth. That implies a rise in output per person employed of some 0.6 per cent. Either trend growth in productivity is substantially lower than the 2¼ per cent now assumed by the Treasury or the flexibility of the labour market has been considerably impaired, or both. These are disturbing notions.

The less one believes in the Treasury’s estimates of the output gap and the productivity trend, the less confidence one can have in the forecast rebound in growth to between 2¾ and 3¼ per cent in 2007 and 2008. That must also make the fiscal forecasts substantially less credible. Yet this is not the only cause for concern. While the Treasury has done a good job of forecasting the economy, until this year, its forecasts of the fiscal performance have been wildly adrift. As the Institute for Fiscal Studies pointed out, for the seventh forecast running, the current budget is overshooting the chancellor’s targets.

The chancellor still expects a substantial rise in the ratio of current fiscal receipts to GDP, from 39.4 per cent of GDP this year to 40.6 per cent in 2008-09. The prognosis for a steady shift in the current budget, from a deficit of 0.9 per cent of GDP this year to a surplus of 0.5 per cent by 2008-09 depends not only on a strong economic recovery, but on a sustained rise in the tax take from a given GDP. Even so, it is largely by shifting the start of the present economic cycle to the first half of 1997, from 1999, that Mr Brown is able to claim that his “golden rule” – that the current budget will be in balance over the cycle – is met. The forecast that public sector net debt will be only 38.2 per cent of GDP in 2008-09 is also vulnerable to adverse out-turns for trend output or fiscal buoyancy.

Moreover, even under these optimistic views, public spending is set to peak next year as a share of GDP and fall by 0.7 per cent of GDP by 2010-11. Mr Brown is, it appears, about to follow the Tory principle of letting spending grow more slowly than GDP. Yet this may not be tight enough if optimism on the economy and fiscal buoyancy prove misplaced, as seems likely. Labour has used up all – probably more than all – of its margin of fiscal manoeuvre. It must now face painful choices.

Even more disturbing, however, is the weak productivity performance. This is the biggest challenge, not least for Labour’s cherished public sector. If the recent deterioration proved permanent, the government would go through the ice. Productivity creates prosperity. It is that simple.

martin.wolf@ft.com

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