Sunday, 1 August 2010

Whatever happens, the buck will stop with the Chancellor

Hugo Radice

WHEN the post-election dust settled and George Osborne moved in to the Treasury, one of his first acts was to set up the Office for Budget Responsibility (OBR).

This latest addition to the roster of economic policy institutions had been trailed in February. Osborne claimed that the Treasury had provided first Gordon Brown, and then Alistair Darling, with whatever forecasts they wanted that would support their political decisions. From now on, the Treasury's forecasts would be vetted by an independent body; as a result, the Chancellor's public credibility
would be restored.

Trailed as an innovation on a par with Gordon Brown's 1997 decision to set up an independent Monetary Policy Committee at the Bank of England, the OBR looked like a potentially useful body. Two months on, however, Osborne's plan seemed in tatters.

First of all, after a Treasury leak raised serious questions about the employment forecasts presented in the coalition's Emergency Budget, the OBR rushed out some fresh figures conveniently in time for David Cameron to head off the critics during Prime Minister's Question Time. Shortly after, it was announced that the OBR's first chief, former top Treasury adviser Sir Alan Budd, was going to resign after only three months in post. It also turned out that for all its vaunted independence, the OBR had set up shop within the Treasury, a few doors down from the Chancellor.

Was this another political fiasco, on top of the abrupt departure of David Laws, the Chief Secretary to the Treasury? Had the unexpectedly self-confident Mr Osborne shot himself in the foot? Well, not really. It turned out that Mr Budd had all along only intended to head the OBR for three months in order to get it established. As for the physical location of the OBR, one might as well argue that the Chancellor's residence at 11 Downing Street meant that the Prime Minister could easily keep him on a tight leash: try telling that to Tony Blair.

However, the establishment of the OBR does raise some important issues about how economic policy is made in a democracy. Back in 1944, the Polish economist Michal Kalecki famously predicted that as government spending became more and more important, governments would be tempted to engineer a boom towards the end of their term of office, in order to get re-elected. Once back in power, they would then slam on the brakes and restore the fiscal balance, only to start spending again as the next election loomed.

He called this "the political trade cycle". The post-war experience of stop-go economics in Britain seemed to bear out his prediction.

To avoid this political manipulation, a fiscal authority independent of the government of the day might seem to be a good idea, but it would make ministerial government completely pointless. Fair enough in a dictatorship, but it is hard to see how such a move would be acceptable to the political élite, let alone a democratically-inclined public.

Given this, Osborne's OBR is an attempt to shore up the Chancellor's credibility by at least ensuring that the taxation and spending commitments are based on rock-solid forecasts of where the economy is going. And here we come to the real problem: rock-solid forecasts do not and cannot exist in a market economy. As we know only too well from the credit crunch and the downturn which followed, the behaviour of financiers, businessmen and other economic actors – even politicians – is fundamentally unpredictable: they are human beings after all, not machines. This means that economic forecasts depend heavily on what we might call educated guesswork.

So what about the OBR's forecasts? They expect economic growth of 1.2 per cent this year and 2.6 per cent to 2.8 per cent thereafter, despite falling public spending, notably a halving of public investment in areas like roads and schools. A rapid and sustained private sector recovery will, they say, reduce the number of unemployed people claiming benefits, from 1.6 million last year to 1.2 million by 2014. Such a recovery in private sector activity has never been seen before after a major economic downturn.

But in addition, the OBR expects that the profits of the financial sector will grow at nearly 9 per cent this year and 6 per cent a year thereafter, giving a big boost to tax receipts. It is very hard to see how this can be reconciled with the need to rein in the City's more speculative activities, as well as building up the financial reserves of the banks in order to avoid a repeat of the credit crisis.

The real story about the OBR, therefore, is not its independence, but whether its forecasts turn out to be accurate. In any case, however things turn out, the buck will always stop with the Chancellor.

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