Pre-Autumn Budget 2017 - Things to look out for

Photo by Sgt. Aaron Hostutler, U.S. Marine Corps (Flickr) / CC BY

It's time for red boxes, stats galore and best-laid plans for the economy. That can only mean one thing: it's almost Budget Day.

Philip "Spreadsheet Phil" Hammond, Chancellor of the Exchequer is to give his first autumn budget, laying out the expectations for growth, government spending and a bunch of other statistics, along with a handful of eye-catching policy announcements to chew on. What issues are at play going into the new budget?

1.) Expectations for growth may be lowered

One of the main topics that will be spun during and after the budget is the forecast for UK GDP growth from 2018 and beyond. In days of old, economists estimated that the UK economy had a trend growth rate of about 2.8% per year. Much of that was thanks to growth in the labour force, but the bulk of the figure stemmed from productivity (the measure of how productive UK workers are). However, productivity and by association, GDP growth in general have taken a bit of a knock since the global financial crisis in 2008.

Productivity is a structural economic component that takes years to shift in a meaningful way. (As a sidenote, President Trump claims he can shift US GDP growth from 2% to 4% or higher, but is unlikely to do so for the following reason). Labour force growth, another major component of economic growth, is a demographic/social issue. Governments have much less control over how the population shifts within a country's borders, unless they adopt draconian policies like one-child policies or severely restrict immigration.

Bringing this back to the UK's situation. Productivity growth has averaged just 0.8% a year since 2010. Growth in the labour force has fallen a bit to 0.5% in recent times. Combine productivity with labour force growth and you get a possible potential growth rate of just 1.3% for the UK. That's right, potential growth is likely to be half what it once was. One of the things to watch out for in the budget is the likelihood of the forecast growth being below 2%, something that Chancellors would have thought unthinkable in the past.

2.) The budget deficit persists

Since the early 2000s, the UK government has consistently spent more money than it received in tax revenues. As a result, it has borrowed billions of Pounds, sending the national debt above £1.6trn. The financial crash blew a hole in the government budget, causing an annual deficit of over £150bn in 2009. In recent times, the Tory-Lib Dem and now Tory governments have whittled it down with a combination of gruelling spending cuts and controversial tax rises. The last Chancellor pledged to eliminate the deficit by the time of the 2015 election. The 2015 election came and went and the government is still running a deficit of about £40bn since April 2017.

Fresh data today may provide a headache for the Chancellor. Borrowing was marginally higher than expected in the latest release. We have just a few more hours to wait before we see what numbers the Chancellor will pull out of his red box. Can he make sure he pulls the budget itself out of the red too?

3.) Unemployment is down but wages are falling in real terms

The Chancellor made a gaffe over the weekend on the subject of unemployment. Contrary to his choice of words, 1.4 million Brits are currently out of work. That equates to about 4.3% of the labour force, a level not seen since the mid-1970s. Sounds pretty remarkable on the surface, but what's happened to pay packets for those in work? As unemployment hits this seemingly golden low number, wage growth has failed to pick up, which you'd expect if the labour market was tightening. Since 2008, wages for those in work have failed to keep up with inflation. Wages grew briefly in real terms between 2014-16, but much of this was thanks to a fall in oil prices during that period.

Following the fall in the Pound after the EU referendum, wages have resumed a decline in real terms for many months now. For public sector workers, wages have been frozen close to 1% for years, so the squeeze has been virtually constant since 2008. Private sector workers saw marginally higher wage growth during the same period, but even they are a bit out-of-pocket. Falling wages matter because they supply the Chancellor with tax revenue. If a significant proportion of the working population are seeing wages fall or if they fail to even have a salary high enough to be taxed, his numbers won't add up going forward.

4.) Relationships between PMs and Chancellors matter

The state of a relationship between the occupant of Number 10 and Number 11 can make or break a government. In the Thatcher era, it turned toxic. The Blair years were marred by the tension over Tony Blair's plans after leaving Number 10. David Cameron and George Osborne enjoyed a steadier relationship over 6 years, but when the country voted to leave the EU, they were gone in quick succession.

Theresa May allegedly considered sacking Mr Hammond in the event of a Tory majority in the June elections, according to the Daily Mirror. Obviously this failed to come to pass, and he remains in place for now. This gives the Chancellor and the PM a less than lukewarm set of relations this time round. The budget is seen as a test, a moment of truth for the Chancellor to salvage the government and provide a statement of intent about the government's objectives as Brexit negotiations fill the headlines. One more slip-up and Mrs May could consider replacing him.

Budgets are tests for economic competence of governments. It's hard to keep up-to-date on every economic statistic or to follow every forecast and point out where it went wrong. However, budgets do matter and are often defined by amusing or seemingly minor announcements, such as George Osborne's so-called "pasty tax" from the budget dubbed by his detractors as the "Omnishambles" budget. It all depends on what comes out of the Chancellor's mystery red box...

Is the government losing its grip?

Photo by © UK Parliament/Jessica Taylor (Flickr) - CC BY

It would be an understatement to say the government has had a bad year; there's still room for things to get even worse before Christmas.

There was a time in the aftermath of the 2015 general election when the Tories appeared unassailable. They had finally broken the curse of the wilderness era and managed to win a majority of seats (albeit a narrow majority). Cameron was riding high in a warm spell of rising real wages. Inflation was at its lowest levels since 1960, when another old Etonian had occupied Number 10, Harold Macmillan (or "Supermac" as the press dubbed him).

Events in the last twelve months have broken this cosy picture asunder. Wages have been falling following the Brexit inflation spike. The economy is still growing but this is more down to the quick-response policies of the Bank of England in the aftermath of the EU referendum. The Pound in our pockets is just what it once was, especially after the referendum. It's gained 9 cents against the Dollar since the October 2016 trough so it's not plumbing the depths right now but millions of Brits have felt their money falling that bit shorter abroad since June 2016.

With this prolonged spell of falling real wages in mind, it's no wonder the snap election was such a disaster if you really think about it. The feel-good factor in May 2015 was long-gone and a new mood of uncertainty has crept in. In place of optimism, the British right-wing allowed itself to adopt a defensive and prickly demeanour. 

The left initially seemed too busy being at war with itself to notice but once Mr Corbyn had cemented his place as Labour leader in the summer of 2016, things seemed more set-in-place. The sections of the press in May's favour spoke of crushing the saboteurs. Judges were dubbed "enemies of the people" and untruths of the referendum campaign (£350m a week et al) suddenly dropped off the headlines. Brexiteers have viewed any moves to scrutinise the Brexit process as sabotage.

The failure to clinch victory in June 2017 served as a shock to the Tory party's nervous system. The populist tide that ensured a Leave victory and Trump's ascent to the White House has now gridlocked the British political system. Discontent has since started to bubble inside the Tory party, to the point where even the Foreign Secretary seems to feel bold enough to dictate the terms of Brexit in a leaked memo to Mrs May. 

It's impossible to speculate on just how many Tory MPs wish Mrs May to stand down. 15% of Tory MPs (48 as of 8th June) are required to hand in a letter to the 1922 Committee chair to trigger no confidence proceedings.  Only the committee chair knows exactly how many letters are on file. However, the Daily Mail reports that as many as 40 MPs may be prepared to do so.

Looming budget to heap the pressure on Downing Street

At the point where the government is in desperate need of respite, the clock is ticking down to the next major hurdle: the autumn budget is unveiled in ten days. Following a grim assessment on the state of the UK's productivity by the Office of Budget Responsibility, it would be reasonable to expect to see a downgrading of UK growth forecasts and a worsening fiscal picture.

Weak wage growth feeds into lower tax revenues. Weaker-than-previously-expected productivity in the future will likely make the UK's national debt a greater burden as a proportion of GDP. Fiscal hawk Brexiteers expecting some kind of Brexit budgetary dividend are setting themselves up for a grand disappointment.

With interest rates finally seeming to be on the rise again, the economy could soften from here. Rates typically rise to encourage saving instead of borrowing. Consumer spending may wane as households tighten belts. Mrs May and Chancellor Phillip Hammond will have to make even harder choices with a paper-thin grasp on control in Parliament as the economy possibly begins to slow. 

The government might be inclined to raise taxes and try and keep the public finances lean in the event of weaker growth. A potential rise in diesel duty has been reported in recent days. It might be pursued promote greener sources of energy. History may start to repeat itself in an economic sense with fatal consequences for the governent. In 1987, the Tories were riding high as the economy boomed after tax cuts and almost a decade of Thatcherism.

Within a year, things got out of hand. Rising inflation by the summer of 1988 pushed Thatcher into a corner and the government responded by hiking interest rates as a knee-jerk reaction. This caused the economy to enter a soft landing; growth slowed, discontent grew and the feel-good-factor was gone. The government began losing its way, introducing toxic policies such as the Poll Tax, one of the most unpopular taxes in British history. Rate hikes in 1988 had the effect of deflating a housing bubble that had developed during the Thatcher era. The Gulf War oil shock of 1990 was the final straw that broke the weak economy's back, sending the UK into a full-blown recession.

The Tories find themselves trapped in a corner again. The economy is likely to soften from here, so any shock could spell trouble. A new election before 2022 will simply compound the sense of electoral fatigue in the country. The Tories might be inclined to wait and see, in the hope that the situation magically rights itself. Unless the UK undergoes a productivity miracle, that remains an increasingly distant chance.