The Office for Budget Responsibility has marked down its growth forecasts significantly. Taking this year together with the next three, the average growth of the UK economy is projected to be less than 1.5 per cent to 2015. This compares with an average growth rate of 3 per cent in the 25 years before the financial crisis.
This is an honest recognition of the “new normal” world facing western economies in the wake of the financial crisis. The world of easy money, cheap imports and strong confidence has disappeared. And we need to adjust to the realities of a global economy that will increasingly be shaped by the rise of China and other large emerging market economies
The chancellor has had to adapt his approach to public finances to this disappointing growth. In doing this, he faced three main challenges.
First, he needed to show his commitment to the government’s strategy of containing public spending and getting government borrowing and debt levels down. That will now take a bit longer than envisaged at the start of this Parliament, when views about the growth outlook were more optimistic. But the UK has won a lot of credibility in financial markets by sticking to a consistent course aimed at deficit reduction. And now is not the time to deviate from it.
Osborne’s second challenge was to come up with additional measures which might help the growth outlook for the economy. Given his limited room for manoeuvre, he did reasonably well here too. There was a modest addition to the government’s infrastructure spending plans – focused on roads, housing and schools. At the same time, tax reductions were focused on helping business. Smaller businesses can now get a 100 per cent tax allowance for £250,000 of capital investment – ten times as much as previously.
The corporation tax rate was cut further to help larger businesses. There was also additional support for exports. And the decision to freeze fuel duties will help the road haulage industry and keep down transport costs in an era of high energy prices. The basic tax allowance is to be raised further, helping to take low-paid workers out of tax and improve work incentives.
The chancellor’s third challenge was to find additional economies in public spending, both to reflect the weaker growth outlook and to pay for more positive measures to support the economy. Government departments will be asked to find additional savings in their budgets. And the increase in benefit payments will be limited to below inflation over the next three years.
These measures will not transform the growth outlook for the UK economy in the short term. But they may help to increase confidence that UK economic policy is on track and that Britain can become a more attractive and competitive place to do business.
Andrew Sentance is senior economic adviser at PwC and a former member of the Monetary Policy Committee.