What does the budget delivered on the 8 March tell us about the economic and fiscal implications of Brexit? The simple answer is very little. Philip Hammond’s speech to Parliament was notable for his dryly humorous (and sometimes self-deprecating) one-liners, but he barely mentioned leaving the EU. Outside the EU, he told us, ‘we cannot rest on our past achievements’ and in several passages he stressed the need to embrace global challenges to emulate ‘our competitors in Germany and the US’ in responding to globalisation.
Practically the only substantive comment on the EU in the speech is openly sarcastic. Commenting on the projected reduction of the UK budget deficit to 2.6% in 2017, he mocks the EU rules that the UK has been in breach of since 2008:
“And for those who care about such things, it means we are forecast to meet our 3% EU Stability and Growth Pact target this year for the first time in almost a decade. But I won’t hold my breath for my congratulatory letter from Jean-Claude Juncker!”
The economy and the public finances
Certainly, the new economic assessments and forecasts accompanying the budget reinforce the message that the vote for Brexit has had no obvious effect on the performance of the British economy. GDP growth is forecast to be steady at 2% in 2017, much the same as in 2016, an outturn in line with what was forecast a year ago in the 2016 budget speech.
The revised forecasts for growth in 2018 and 2019 are less optimistic, at 1.6% and 1.7%, explained by a slowdown in consumers’ expenditure because of a likely squeeze on real incomes consequent on higher inflation.
The improvement in the public finances is also expected to continue, despite the very cautious increases in spending Hammond announced, particularly to counter the crisis in social care. However, the objective of attaining a balanced budget has now been pushed further into the future.
In one of the accompanying documents, the Office for Budget Responsibility (OBR) observes that public borrowing is ‘likely to be significantly lower this year than we anticipated at the time of the Autumn Statement in November, largely reflecting one-off factors and timing effects that flatter the figures at the expense of next year.’
Borrowing is now projected to increase again in 2018 before returning to its downward trajectory. Public debt will probably reach a peak as a proportion of GDP in the 2017/8 fiscal year before starting to edge downwards. Although the OBR expects the improvements in the public finances to continue, it is critical of the longer-term trend, finding that ‘the Government does not appear to be on track to meet its stated fiscal objective to “return the public finances to balance at the earliest possible date in the next Parliament.’
All these projections are on the assumption – unchanged from those made by the OBR in assessing Hammond’s Autumn Statement last November – Brexit occurs in a reasonably smooth manner in the second quarter of 2019, albeit with some further negative effects on the economy from uncertainty and higher inflation induced by the fall in the pound. Not unreasonably, the OBR has chosen to make only broad-brush assumptions about the nature of Brexit, precisely because the government has yet to reveal its detailed objectives for the negotiations.
Unlike members of the eurozone, the UK has only ever been subject to what is known as the ‘preventative’ arm of the Stability and Growth Pact (SGP), which enjoins member States to aim for a budgetary position close to balance or in surplus over the medium-term and to restrict any annual deficit to 3% of GDP. Those outside the eurozone are not subject to the ‘corrective’ arm under which countries could ultimately be fined for having excessive deficits.
As a result (and as the Chancellor’s comment lays bare), the UK could breach the rules with impunity because there were no consequences. Indeed, even before last year’s EU referendum, the UK paid little heed to the various instruments of EU economic governance in what is known as the European semester.
Many economists regard the SGP rules as misconceived and argue they have been inappropriately applied during the euro crisis. There is, however, a wider debate about whether constraining fiscal policy by having numerical rules makes sense. Such rules have proliferated in recent years among OECD countries and, along with the establishment of independent fiscal councils (the OBR is the UK’s fiscal council), have latterly been at the heart of fiscal policy governance.
When Gordon Brown was Chancellor he adopted two fiscal rules, one which sought to limit public debt as a percentage of GDP to 40% (contrast this with the 2016 figure of 87% and the 89% expected in 2018), measured over the economic cycle, and to borrow only to finance public investment (the golden rule). Although Brown was accused of sleight-of-hand for redefining the duration of the economic cycle, these rules broadly held up to 2007, but had to be suspended during the crisis years.
When George Osborne became Chancellor, he shifted the approach to one which set a medium-term target for attaining balance in the public finances and another setting a deadline for debt to start falling as a percentage of GDP, both enshrined in a ‘Charter for Budget Responsibility’ approved by Parliament.
However, he kept changing the target dates, something Hammond has continued, pushing them into the next Parliament rather than the end of the previous Parliament (2015) as Osborne originally envisaged. In practice, therefore, the UK now has ‘rules’ so flexible that they provide little, if any, discipline on the public finances.
If Brexit proves to be harder or a more hostile exercise than the government hopes, the risks to the economy are likely to be mainly on the downside. Philip Hammond’s first budget is best described as cautious, but with weak fiscal rules and little room for manoeuvre, there are grounds for concern about the vulnerability of the public finances.
By Professor Iain Begg, senior fellow at The UK in a Changing Europe and Professorial Research Fellow at the European Institute, London School of Economics and Political Science.