OBR report shows extent of lost economic potential

Of all the decisions the chancellor has made, the one he may be regret the most is making the Office of Budget Responsibility (OBR) independent.

George Osborne 2

Of all the decisions the chancellor has made, the one he may be regret the most is making the Office of Budget Responsibility (OBR) independent.

Last week the OBR released its report on the budget which showed not only the failings of the current government’s strategy, but which also gave good indicators to what the future economic strategy should be.

One of the most striking revisions it disclosed was the widening of the output gap for the UK economy. This is the gap between what the actual economy output is in comparison to the current potential capacity.

For 2013 it has been widened to -3.8 per cent,(p39). In other words, the economy is losing out on up to £60 billion potential growth this year. The total loss of potential output by 2018 is now around one third of a trillion pounds, with subsequent tax receipts of £100 billion (which is the equivalent of the whole health budget for the UK).

This is output that is sitting there waiting to be tapped.

The graph below tracks lost growth with that of real growth up to the year  2017. The lost growth is far higher than our real growth– an worrying situation.

Graph Ranjit

This situation is pretty much unheard of for a medium term forecast as an economy would tend to balance itself – the Congressional Budget Office have forecast that the US Output Gap will have closed by 2017 (see below graph). As the OBR itself ruminates in page 45 of its report:

“In normal times it would be unusual to forecast that the economy would be operating with significant spare capacity at the end of a five year forecast horizon”.

Graph Ranjit 2

They point to the “weakness of the subsequent recovery” for the widening of the output gap with “fiscal consideration” being one of the main factors for a lack of UK demand. The required actions could not be clearer: we need to stimulate demand to get that lost growth back.

This is not a new theory; it is one that has been a post-war economic stable, which these OBR figures again validate.

The present government have been extremely vocal about not leaving a  “legacy of debt”, but the OBR gives this short shrift, stating that the changes in Public Sector Net Borrowing (PSNB) for 2012 to 2014 have been “fiscally and statistically insignificant” (p12).

With tax receipts for the government dropping a further £5 billion this year, the economic legacy highlighted by this OBR report is the lost potential of the UK, undertaken by a government not prepared to accept it’s mistakes and adopt a more tried and tested economic theory.

8 Responses to “OBR report shows extent of lost economic potential”

  1. Ash

    Here’s a straightforward question I’ve never heard answered: how large does the gap have to be, and for how long, before some loss of productive capacity is judged to be permanent?

    As I understand it, there’s a window of opportunity immediately following a recession during which the economy can (and usually does) make up for all the lost growth, so that after a few years it’s as if the recession never happened and the economy just grew steadily at its long-term trend rate. But if this window is missed, the rot sets in and productive capacity is permanently lost (e.g. because entrenched unemployment has eaten away at the skills and experience of the workforce).

    This has direct implications, presumably, for the size of the structural deficit. We were told in 2010 that a typical post-recession bounceback would eradicate the *cyclical* part of the deficit (as usually happens), but that on this occasion – due to a permanent loss of productive capacity in the economy caused by the crash of 2008 – a *structural* deficit would remain unless closed by tax rises and/or spending cuts. The Tories’ idea, then, was to shrink the structural deficit by raising taxes and cutting spending, while leaving the cyclical deficit to take care of itself as the economy grew.

    But the economy hasn’t grown, and surely past a certain point we have to question whether the part of the deficit we assumed was cyclical is still, in fact, cyclical, or whether it’s become structural due to a further permanent loss of productive capacity?

  2. Ranjit Sidhu

    Ash: “and surely past a certain point we have to question whether the part of the deficit we assumed was cyclical is still, in fact, cyclical, or whether it’s become structural due to a further permanent loss of productive capacity?”
    Absolutely:
    In my humble opinion; the clear problem is a lack of demand and if we are not only trying to boast demand, but actually inadvertently dampening it, there will be a point when the damage is permanent as the economical cycle has been disturbed, unconventionally. Also, there is Japan which clearly is a big warning.

    TIm Duy and Felix Salmon had a good, but incomplete discussion on this recently.

    This may be also be missing the bigger issue- that of the human cost in the convening years that is being missed by not minimising the output gap as soon as possible.

  3. Ash

    Thanks for the reply Ranjit. I suppose what I’m wondering is where the tipping point comes in terms of assessing the success or failure of government policy. At what point does (did?) the OBR go from saying: ‘the structural deficit is coming down, but the cyclical deficit is taking longer than we hoped to get rid of’, to saying ‘actually, we now realise that the structural deficit has not been falling at all. In fact it’s been growing’? I’ve struggled to find any up-to-date figures/projections of the structural deficit, as opposed to the overall deficit.

  4. Ash

    Thanks for the reply Ranjit. I suppose what I’m wondering is where the tipping point comes in terms of assessing the success or failure of government policy. At what point does (did?) the OBR go from saying: ‘the structural deficit is coming down, but the cyclical deficit is taking longer than we hoped to get rid of’, to saying ‘actually, we now realise that the structural deficit has not been falling at all. In fact it’s been growing’? I’ve struggled to find any up-to-date figures/projections of the structural deficit, as opposed to the overall deficit.

  5. Ash

    Thanks for the reply Ranjit. I suppose what I’m wondering is where the tipping point comes in terms of assessing the success or failure of government policy. At what point does (did?) the OBR go from saying: ‘the structural deficit is coming down, but the cyclical deficit is taking longer than we hoped to get rid of’, to saying ‘actually, we now realise that the structural deficit has not been falling at all. In fact it’s been growing’? I’ve struggled to find any up-to-date figures/projections of the structural deficit, as opposed to the overall deficit.

  6. Ash

    Thanks for the reply Ranjit. I suppose what I’m wondering is where the tipping point comes in terms of assessing the success or failure of government policy. At what point does (did?) the OBR go from saying: ‘the structural deficit is coming down, but the cyclical deficit is taking longer than we hoped to get rid of’, to saying ‘actually, we now realise that the structural deficit has not been falling at all. In fact it’s been growing’? I’ve struggled to find any up-to-date figures/projections of the structural deficit, as opposed to the overall deficit.

  7. Ash

    Thanks for the reply Ranjit. I suppose what I’m wondering is where the tipping point comes in terms of assessing the success or failure of government policy. At what point does (did?) the OBR go from saying: ‘the structural deficit is coming down, but the cyclical deficit is taking longer than we hoped to get rid of’, to saying ‘actually, we now realise that the structural deficit has not been falling at all. In fact it’s been growing’? I’ve struggled to find any up-to-date figures/projections of the structural deficit, as opposed to the overall deficit.

  8. Ed Conduit

    Some specifics for Plan B

    Whoever takes government in 2015 will inherit an unenviable economic situation, including
    public debt at 80% of GDP. We think of that government’s principal task as making
    selective state spending that will return more than the outlay. Put in
    commercial marketing terms, the state needs to identify unmet demand in a down market
    opportunities to generate new revenue. Obviously social welfare issues are also
    important, but we need to keep focused. Please consider the following policy
    ideas for tapping spending power in a recession:

    1. Convert empty buildings to council flats. This is now a consensus between Ed Balls, George Osborne, and the CBI about affordable
    housing. However, George Osborne’s plan for mortgage loans for private building
    is not the best option. The mortgage schemes in the March 13 budget are being
    snapped up by wealthier house-owners. Councils could commission conversions of
    empty office into flats, either for lease or for council purchase. Central
    government could raise the money by issuing two-year gilts at 0.2% interest. The
    income in council rents would promptly repay the gilts and remove the loan from
    the PSNCR. Conversions also give VAT income to government, by contrast with
    new-build.

    2. Electricity generation. Power that is below the strike price of 10p per kWh set by Qatari gas will be readily sold. The likely schemes are:

    a. Biogas. Food waste, grass
    cuttings etc can be fermented to give methane, which drives gas turbines to
    generate electricity. Ludlow currently has such a scheme, in which the local
    council collects the waste and sells it as feedstock. Round Hill sewage works
    and Russells Hall Hospital also have such generation schemes, though the power
    generated is used within the plant.

    b. Gasification. Waste including end-of-life cars can be burnt to generate steam for turbines. See e.g. the new Chinook plant at Oldbury. Such plants can also sell waste heat for
    public buildings (CHP). Here again the council could be the selling point for
    the feedstock.

    c. Hydro-electric. English rivers generally have low heads so big hydro schemes are impractical. Weirs of a few metres head, or suspending turbines in-stream are possible. In-stream milling was the historic method of grinding flour in the Seine.

    3. Public sector tourist attractions. The UK is the world’s 7th
    biggest tourist destination, with 29.2 million visiting in 2011 and spending
    US$17.2 billion. Chinese visitors are the most
    numerous. The weakness of the pound makes the UK attractive. London is by far
    the most-visited capital in the world. There is additional scope for expanding
    internal UK tourism, for example to recent retirees. Olympic heritage sites are
    likely venues. A possible re-enactment is:

    · the charge of the light brigade. There could be a small number of actual horses and riders, and laser and holographic horses for casualties. The jingoistic effect might be offset by
    Tennyson’s sorrowful poem.

    Events from Labour history (the 1819 Peterloo massacre, the Miners’ strike, the Peasants revolt of 1381) could be alternated with nationalistic
    themes (Elizabeth I addressing her army, Henry V at Agincourt). The government
    would gain revenues from ticket sales, and also indirectly from corporation and
    income tax from the hotel industry.

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