The rise of the economic technocrat has transformed our policy landscape. In 1997, the New Labour Government made the Bank of England independent. Then, in 2010, the Cameron-Clegg coalition created the Office for Budget Responsibility (OBR). Now, both the Bank and the OBR have grown in importance, with their decisions permeating across the economy and politics.
Today sees the release of the third five-yearly, ‘External Review of the Office for Budget Responsibility’. This was conducted by Laura van Geest, Chair of the Dutch Authority for Financial Markets. The findings of such a Review are of political significance, as the combination of high debt, fiscal rules and little fiscal headroom mean the OBR’s decisions are increasingly important for policy.
The recommendations from this Review will empower the OBR. The OBR has ‘done a good job’ and has, ’emerged stronger’ over the last five years, is the message. Moreover, amendments announced by the Chancellor last autumn – such as the updated Charter for Budget Responsibility including a fiscal lock and changes to the setting of departmental expenditure limits – have ‘cemented the OBR’s central place in the UK economic and fiscal landscape’. This marks a stark contrast with the report by Ben Bernanke on the Bank of England last year, which was damning. Instead, this Review notes that evidence it received on the OBR was responsive, transparent and open to evolving analysis.
I take a positive view of the OBR and was one of those who gave evidence to the Review. Although I agree with the tone of the Review, my concern is with the organisation’s direction of travel and that the growing political need for an endorsement from the OBR may now be influencing policy.
Eleven recommendations are proposed, focusing on independence, the infrastructure around the OBR’s modelling and on impact, including the need to focus more on fiscal sustainability.
Independence permeates through the Review. Recommendations on funding and reporting are not controversial and there are also suggested changes to the appointment process. The trouble, however, is that valid criticism about the credibility and competence of institutions can be often rebuffed as if a challenge to their integrity and independence.
The second focus of the Review is the OBR’s modelling. It calls for clear criteria by the OBR on its dynamic scoring. This is the Review’s most important component, as it goes to the heart of the present debate. Dynamic scoring is about how the OBR judges announced, but yet to be delivered economic policies. The concern is the positive impact of policy will be underestimated, with downbeat economic and fiscal projections.
The OBR has previously set a high bar for policy changes to be seen as impacting potential growth, but there has been progress in recent years. For policy changes to impact the OBR’s projections, they need to be significant, additional to existing to policy, expected to have a lasting impact and proof of their impact would need to be evidence-based. In a new report, Gemma Tetlow of the Institute for Government (IfG) provides a good analysis of these implications.
The reason this is so important is twofold. One is that the debt position is poor and thus if growth prospects do not improve – or the OBR does not believe policy decisions will boost growth – then the fiscal rules point to tax hikes or spending cuts. Another, is that the current direction of travel is for the OBR to exert greater influence over future policy choices.
On the positive side, this means the OBR does not just believe the spin around policies, but on the negative, it may miss a combination of incremental policies as opposed to significant ones, it may not reward novel policies because they have not been tried before, and also – crucially – it may lead to a back-to-front policy process. For instance, as the IfG points out, when Jeremy Hunt was Chancellor, policies were outlined to the OBR to see what the impact might be on growth and fiscal projections. Hunt opted for cutting national insurance as opposed to reducing income tax as the OBR judged that this would boost the labour supply, and thus potential growth, by a greater amount. Likewise, it was reported widely at the time that plans to cut migration were relaxed for fear it would reduce growth forecasts and limit room for politically desirable tax cuts.
As things stand, there is a green light for the OBR to involve itself more with its oversight of policy, particularly supply-side measures. I am all for policy decisions being taken that are in the long-run beneficial to the economy – such as boosting future investment – and the hope is that this approach may start to drive sensible, long-term economic policy making. But as the Review itself makes clear, if the OBR is seen to be driving policy, it could lead to ‘gaming’, as politicians try to provide the OBR with evidence to support policies they favour or try to hide the implications of others.
When the process drives policy, one has to voice concern. Big issues, though, are the fiscal rules and the fiscal headroom. The Review correctly highlights, ‘the short-term focus of this wider fiscal debate, exemplified by the emphasis on discussion of the fiscal headroom’.
The trouble is, the fiscal rules lack credibility, with frequent iterations. There have been 10 changes, with 28 different rules, since their inception in 1997, and they are often changed at the first sign of trouble. Also, they can tie policymakers’ hands unnecessarily. Last autumn, the Chancellor set out the latest version, with a stability rule, an investment rule and a welfare cap, while also adopting a broader balance-sheet measure of debt. None of this, though, changes the underlying issue: spending, tax and borrowing are too high.
The Review’s recommendation for the OBR to ‘crowd-in’ expertise in policy areas sounds logical, but the danger is that this creates a formidable obstacle if a new government, with a fresh mandate, wants to execute policies that the economic consensus is not favourable to. After all, there are occasions when the consensus has been proved wrong, and the idea of hard-wiring current fiscal fashions into policy could pose future challenges.
Increasingly, the media portrays the OBR’s forecasts as if they are certain. While its forecasting record compares favourably, the margin of error on one-year ahead growth is 0.5%, which in turn adds to the error on the budgetary forecast. None of this is a surprise, or a criticism, it is the reality of an ever changing domestic and global environment. Uncertainty has also led the OBR to alter its forecast for potential output on a frequent basis.
Finally, the last set of recommendations on ‘impact’ make sensible comments on explaining medium-term forecasts and focusing on fiscal sustainability. Yet the OBR does produce a 50-year fiscal projection, and perhaps this is the report that Parliament should spend more time reflecting on.
The full power of the OBR will be seen when it publishes its spring forecast on March 26. The weak economy suggests there will be little fiscal headroom, and if there is no headroom, then the fiscal rules imply action is necessary.
There are five routes out of high debt: growth, reform, austerity, tax or borrow. With growth sluggish and meaningful public sector reform unlikely, the Chancellor has little room for manoeuvre. The tax take is already high and to increase it further would dampen growth. Austerity is politically difficult, yet the comprehensive spending review and future defence needs may push public expenditure up, while borrowing is already high and the need to keep international investors on-side is paramount.
The UK faces a debt trap, with drastic action necessary, and that is the message politicians need to hear and listen to from the OBR.
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