UK fiscal update: Counting the Brexit costs

Just four months after the Chancellor presented an autumn budget, and with no new fiscal measures scheduled today, it was rather puzzling why the OBR bothered to churn out the standard 243 page Economic and Fiscal Outlook following today’s Spring Statement. It was, as usual, a thorough and considered analysis of the current situation in the UK and contained an updated forecast, but it all seemed a bit superfluous. So what did we learn?

First, that the OBR’s medium-term forecast remains broadly unchanged compared to November, and second, that the fiscal outlook has improved a bit, with a cumulated reduction in borrowing of around £20bn over the forecast period. In other words, nothing to write home about. With regard to the growth outlook, recall that the OBR cut its medium-term projections in November by reducing the outlook for productivity growth. I did note at the time that this might have been a little premature, primarily because a tightening labour market might be expected to boost capital investment which in turn would lead to a faster pickup in spending relative to labour input. As the OBR acknowledged, “the biggest surprise in the economic data released since November is that productivity growth – measured as output per hour – has been much stronger than expected.” But since this reflected an unanticipated decline in hours worked in H2 2017, which the OBR expects will be reversed, the fiscal watchdog sees no reason to change its view regarding its medium-term productivity assumption. The jury is still very much out.

With regard to fiscal projections, however, it is evident that the UK has now managed to bring current income and outlays back into line. Having reduced the current deficit from 6.5% of GDP in 2009-10 to zero, you might think that now is a good time to pause and rethink the austerity strategy. The bulk of the reduction has fallen on public spending, whose share in GDP has fallen by a whopping 6.3 percentage points over the last eight years whilst the revenue share is only up by 1.4 points. To the extent that the current balance effectively measures the day-to-day cost of running the public sector, it is now clear that services have been reduced to levels which can be covered by tax revenues. In any case, it is possible to stabilise – and even reduce the debt-to-GDP ratio – so long as the primary balance is broadly zero and the rate of nominal GDP growth is higher than the interest rate on government debt. Seeking overall balance on total borrowing, which implies that today’s taxpayers are paying for investment that will be enjoyed by future generations, makes little sense.

I have pointed out many times previously (here, for example) that there is only so much austerity that can be put in place without cutting front line public services beyond the point of no return, and with the strain on health and welfare services unlikely to improve there is a case for raising expenditure in both areas in the near future. Incidentally, I was struck by the French government’s recent suggestion to scrap all jail sentences of less than one month on the grounds that they are both costly and counterproductive. With the UK prison service struggling under the burden of cost cuts, it seems to me that part of the austerity drive in future will not be how to do more with less, but simply how to do less.

One of the key areas of interest in the OBR’s publication was its attempt to quantify the cost of the Brexit divorce bill, which it puts at £37.1bn – 75% of which will be incurred by 2022. Whilst this is at the lower end of the estimates which have been bandied around over the past year, largely because the UK will continue paying into the budget until end-2020, by my reckoning this is about £10bn more than the UK would have otherwise paid to stay in the EU over 2021-22. Moreover, the UK will continue paying off its liabilities until 2064 (chart). The OBR also pointed out that the UK will continue to pay into various EU funds in order to retain access to specific schemes – although the government was unable to suggest how much this will ultimately cost because it has not yet decided in which schemes it wishes to participate.

It is clear, however, that there will be ongoing EU liabilities above and beyond the divorce bill, which will put further pressure on the budget, and highlights that a “clean Brexit” is virtually impossible. Although the OBR was too polite to say so, the notion that the UK will make savings from no longer having to contribute to the EU budget, which can be used for other purposes such as the NHS, is a complete and utter fiction. Here’s looking at you Boris!