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12 Mar 2020

Economy

budget

This budget was all about preparing the economy to deal with coronavirus.

Fortunately, the Chancellor showed he recognised the magnitude of the challenge – announcing a £30 billion fiscal stimulus including targeted support for workers and small businesses that face the biggest economic risks. More may be needed as the epidemic unfolds, but the budget was a step in the right direction.

For a new Chancellor, his first budget (and it always has been a man) is an opportunity to set out a vision for fiscal policy. When Rishi Sunak was appointed four weeks ago, this was no doubt his intention. There was talk of levelling up, rewriting fiscal rules, loosening the purse strings.

But then the goal posts moved. Coronavirus is likely to cause a sharp, albeit temporary, slowdown of economic activity in the UK and around the world. As a result, the focus of the budget shifted to dealing with coronavirus. Everything else is of secondary importance.

The plan to increase public investment and support for research and development is overdue. However, the feasibility and desirability of the tax and spending changes pledged by Mr. Sunak will have to be revisited once the full economic consequences of coronavirus are apparent.

Even Brexit takes a backseat for now – although coronavirus provides another reason to extend the transition period beyond the end of this year. Indeed, Michael Gove has told the Brexit select committee that the next round of talks may have to be cancelled.

There are three aspects of coronavirus that the budget needed to address. First, and most important, additional funding for the NHS. The Chancellor announced the NHS will get whatever extra resources it needs, with an immediate £5 billion funding increase.

This is welcome and now the government needs to follow through on its pledge and set about reversing a decade of underinvestment in the health service.

Second, from a macroeconomic perspective coronavirus is both a supply shock and a demand shock. Shut downs and financial market distress will not only cause temporary reductions in output, but also lead to cash flow problems that could result in bankruptcy for otherwise healthy businesses.

At the same time, consumer demand for services such as travel and restaurants will decline and many workers without a guaranteed income will struggle to meet their expenses. The most exposed businesses and workers need support until the crisis passes.

The Bank of England moved first, cutting interest rates by half a percentage point and introducing new support for bank lending, particularly to small and medium-sized firms.

On top of this, the Chancellor announced a £30 billion fiscal stimulus this year including measures that extend eligibility for statutory sick pay, make it easier for gig economy workers to access benefits and provide support to small businesses through rate reductions, deferred tax payments, cash grants and targeted lending.

This is a substantial stimulus, although only around £7 billion of the total is targeted towards the workers and business likely to be hit hardest by coronavirus.

Third, it is too soon to know how large the economic slowdown will be or how long it will last. The Office for Budget Responsibility’s forecasts are already out of date, leaving the Chancellor with little guidance over how large a response is needed.

In these circumstances, the best advice is probably to go big, while maintaining the flexibility to adjust policy as more information becomes available. The Chancellor has adopted a bold response, but he must be ready to do more if coronavirus becomes widespread in the UK.

Overall, I would give the budget’s response to coronavirus a B+, although my students would probably say that I am a harsh marker.

And finally, a Brexit epilogue: the budget mostly ignored the UK’s departure from the EU, pushing off decisions until later in the year. But there were a few interesting titbits for Brexit watchers hidden inside the Office for Budget Responsibility’s budget report.

The fiscal watchdog expects that, if the UK and EU reach a free trade agreement, Brexit will reduce UK productivity by around 4% in the long run, and argues that the economy has already experienced a 1.4% productivity decline – around one-third of the expected total.

It also estimates that the decision to leave the EU has reduced UK GDP by approximately 2% so far.

None of these numbers are surprising (although there is considerable uncertainty over how large the long run effects will be). In fact, they are based on academic work by the UK in a Changing Europe and other researchers.

But their inclusion in the report shows that the Office for Budget Responsibility accepts the consensus that Brexit will make the UK substantially poorer than remaining in the EU. That is a challenge for future budgets to grapple with.

By Dr Thomas Sampson, Assistant Professor in the Department of Economics at LSE.

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