Analysts describe as credible a claim that the country’s structural deficit is 25% bigger than previously thought
Julia Kollewe and Polly Curtis
guardian.co.uk, Monday 19 September 2011 17.09 BST
Britain could face many more years of austerity to balance the country’s books, City economists warned, after a potential £12bn black hole was found in the public finances.
A calculation in the Financial Times says the structural deficit — the deficit that persists even if the economy is growing at its full potential — is 25% bigger than previously thought, leaving chancellor George Osborne with a £12bn gap. Plugging it would require new austerity measures equivalent to raising VAT to 22.5%.
Analysts described the claim as credible because the calculation was based on the Office for Budget Responsibility’s own methodology.
Carl Emmerson, deputy director of the Institute for Fiscal Studies, a respected think tank, said: “It’s getting more likely that we are going to have to see more pain in the next parliament – the squeeze in spending will go on or tax rises. The chances of a pre-election give-away look less likely. Austerity is getting more likely to continue into the next parliament.”
However, Barclays Capital analyst Chris Crowe said that even with such a shortfall, the government would still just meet its target of eliminating the structural deficit by 2015/16. It is forecast to hit almost £50bn this year.
“But the margin is so tight, any additional changes in assumptions could tip it over the edge. It’s touch and go,” Crowe said. He has long argued that the government will struggle to hit its fiscal targets, saying the OBR’s estimates for economic growth are too optimistic.
But Crowe said: “Any further austerity measures would be undertaken with reluctance if there is a general deterioration in the economy. It seems clear that the [existing] austerity measures have contributed to the general poor state of confidence, both business and consumer confidence, and so additional measures would only make it worse at this stage.
“On the other hand, the government has set great store by its pledge to meet its targets.”
He thinks that “fairly minor measures” to keep the public finances on track might be unveiled by the chancellor in his autumn statement on 29 November, should the OBR’s latest projections indicate that his borrowing plans are slipping. A Treasury spokesman declined to comment, noting that the official forecast is produced by the independent OBR, which will update its forecasts in November.
Philip Shaw, chief economist at Investec, said: “I’m not convinced that hitting the economy with further tax increases or spending cuts is the appropriate course of action. Could we see a 2.5% hike in VAT? I very much doubt it.
“I would very much question George Osborne’s appetite for further fiscal tightening, let alone the Liberal Democrats’.”
One issue is whether the economy has less spare capacity – ie room to grow sustainably – than previously thought, as Charlie Bean, deputy governor of the Bank of England, conceded last month. “We have a high degree of uncertainty about what the spare capacity in the economy is, but our assessment is that… the recession has led to a relatively long-lasting hit on… spare capacity.”
If there is less spare capacity in the economy than previously thought, a bigger portion of the government deficit will be permanent, rather than being wiped out once the economy bounces back.
As the OBR’s chairman, Robert Chote, explained in March: “The amount of spare capacity you have determines how far the economy can grow in a sustainable way and, therefore, how much of the deficit that we have at the moment will be soaked up naturally as the economy recovers and how much, as it were is left for policy to deal with.” He admitted that the biggest uncertainty in the OBR’s forecasts was whether it had correctly estimated the amount of spare capacity.