We need deficit realism, not blind optimism

It’s complacency bordering on the delusional to think that Britain can afford a spending splurge now

More money for public sector pay, more money for the poor, more money to fund the Universal Credit, more money for infrastructure, more for defence and the NHS, more for training, education, tax cuts, to prepare for a no-deal Brexit, help-to-buy, student loans… As next month’s Budget approaches, the list of demands just keeps on growing, with scarcely a thought, it sometimes seems, ever given to who is actually going to pay for it.

One of the curiosities of Brexit is that it has turned many one-time deficit hawks into spendthrift Keynesians. John Redwood, an uncompromising Brexiteer who once used to lambast the Government for going soft on deficit reduction, now seems to believe that there is plenty of scope “for tax cuts and spending rises in areas that need them”, if only the Office for Budget Responsibility would be more optimistic in its forecasts.

Time for a reality check. The brutal truth is precisely the reverse; at least in the short to medium term, Brexit has limited Britain’s scope for fiscal expansionism, not increased it.

Obviously, there are other factors here beyond the conviction that Brexit makes all things possible. After eight years of belt-tightening, voters are weary of austerity and want a new script. With the deficit back to precrisis levels, there is also a feeling of job done. The sense of national emergency that ruled in the depths of the financial crisis has all but disappeared, and with it political appetite for the hairshirt policies of recent years. Again, time for a reality check.

One of the reasons the public finances suffered such a calamitous collapse in the wake of the banking crisis is that we were already running a very sizeable budget deficit by the time it broke, despite one of the longest periods of uninterrupted growth in British history. There was no room for accidents, and the deterioration was therefore all the more brutal.

To think we can rest on our laurels having finally got the deficit back to where it was just before the crisis – as a proportion of output, if not yet in nominal terms – is complacency verging on the delusional. It would require only the mildest of recessions to send the national debt skyrocketing anew, dragging heavily on future growth prospects.

What makes the UK’S predicament all the more concerning is the country’s still very high external deficit. Apparently impervious to currency devaluation – which has so far failed to close the gap between imports and exports – this shortfall, like the budget deficit, has to be constantly funded, making the UK highly reliant on what Mark Carney, governor of the Bank of England, has called “the kindness of strangers”.

The kindest stranger of all right now is, ironically, the European Central Bank, some of whose money printing leaks out from the eurozone into UK assets and thereby pays for the external deficit. This is coming to an end. Who then will pay for our prosecco and BMWS?

We must of course remain optimistic for the future, but we must also be realistic and pragmatic. Britain’s position is far more precarious than generally appreciated.

Mr Redwood tweeted recently that “the Chancellor must get the Treasury to have more realistic, optimistic forecasts & to find the money for a successful economy post Brexit”. If realism is optimism, then the Office for Budget Responsibility – which assesses the outlook for the public finances and therefore the scope for tax cuts and spending increases – is guilty as charged.

Far from being too pessimistic, the OBR – a rare haven of competence and economic expertise – has in fact been consistently too optimistic, both on the deficit and growth, and has remained so since the referendum. Only last March, it upgraded its economic forecast for this year from 1.4 to 2 per cent. It should have stuck with the original, which is roughly where we are going to end up.

Just recently, the OBR’S chairman, Robert Chote, warned he would be cutting his assumptions for productivity growth, which will admittedly somewhat temper the OBR’S optimism for the future, but this should hardly surprise.

Through thick and thin, the OBR has looked on the bright side and assumed that productivity growth would return to the pre-crisis trend; it hasn’t happened, and nor does it promise to with business investment still so low. There is only so long you can keep up the pretence.

The politics call for the return of “compassionate conservatism”, even if Mr Corbyn’s magic money tree will make it impossible for Tories to outflank Labour on government intervention and entitlements; the economics argue for something else entirely.

I hesitate to credit Jean-claude Juncker, president of the European Commission, with anything like wisdom, but some while back he did manage to coin one of the great political truisms of the modern age; we know what has to be done, we just don’t know how to get re-elected afterwards.