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Why the UK’s Fiscal Charter is Doomed to Fail

Research suggests that the likelihood of achieving the Government’s aim of a balanced budget by 2020 is low

by Sophie Cubbin (PR and Communications Manager)

The Government’s aim of balancing the books by 2020 is unlikely to be achieved if they continue with the current programme of austerity. That’s according to a new report by academics from City University London’s Political Economy Research Centre (CITYPERC).

The paper, Why the UK’s Fiscal Charter is Doomed to Fail, by Professor Ronen Palan (right) and Professor Richard Murphy, analysed the use of austerity economics and its impact during the first and second Cameron governments.

They concluded that by 2020, if Office for Budget Responsibility (OBR) forecasts for the past five years are projected to the future, instead of the planned £10 billion surplus, the government will be forced to report a deficit of nearly £40 billion instead. This would undermine the UK’s current fiscal charter, which dictates that governments borrow only in times of distress.

The paper was released ahead of the Chancellor George Osborne setting out the state of the economy in the Autumn Statement and his spending plans for the next four years in the Spending Review

The researchers found that the Treasury has underestimated the impact of welfare and departmental spending cuts on the broader economy and especially cuts to public sector investment. It suggests that without a boost to public infrastructure, private sector businesses will limit their own investment plans, leading to lower productivity and depressed GDP growth over the next four years.

The report attributes this underestimation to the Office for Budget Responsibility (OBR) adopting an unrealistic fiscal multiplier range for government spending. In economics, the fiscal multiplier is the ratio of a change in national income compared to the change in government spending that causes it.

The OBR has set the UK’s fiscal multiplier range at 0.6 to 1.0, which assumes that for every £1 of public spending cuts, the cost to the economy as a whole is less than 70p.  However, a study by the International Monetary Fund showed it could actually be as much as £1.70 as private businesses recoiled from making long-term investment decisions while the government retrenched.

Speaking to the Guardian, Richard Murphy, Professor of Practice in International Political Economy at City University London, commented: “The very low multiplier the Treasury uses assumes that cuts in government spending will stimulate growth. That’s an assumption, and not a fact.  It is one the IMF now disagree with.

“The result of basing policy on that multiplier is we have more cuts than we need, lower growth in the UK economy as a result, lower earnings for most households and so lower tax revenues – which actually makes balancing the government’s books harder.”

Ronen Palan, Professor of International Political Economy at City University London, says the low multiplier has led to an overestimation of the benefit of austerity and the constant upwards revision of public borrowing needs.

The paper states: “The Office for Budget Responsibility forecasts for balancing the books by 2020 is premised on very significant, and in our view unrealistic, changes in the pattern of behaviour of the private sector within the UK economy and the external sectors over the next few years.

“If the rate of inaccuracy of OBR forecasts from 2011–12 to 2015–16 was replicated in the years 2015–16 to 2019–20 then, based on the July 2015 OBR forecast, an additional £162 billion would be borrowed over this period, and at the end of the 2015-2020 parliament the budget would not be running a surplus of £10.2 billion but would instead be showing a deficit of £39.3 billion.”

The City Political Economy Research Centre (CITYPERC) aims to nurture new thinking on the relationship between economic and political processes through research, publications and partnerships.

Download the full paper

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