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.

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.

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