HAMISH MCRAE: Chancellor must play long game on fiscal policy

HAMISH MCRAE: Bumpy autumn will cost the Government money, but the Chancellor would be wrong to base his fiscal policy on short-term disruption

What on earth will Rishi Sunak make of his upcoming Budget, now ten days away? The background is extraordinary. Massive and worsening trade disruption. Empty shelves at the supermarkets. The fuel shortages. Gas prices through the roof. Inflation heading towards five per cent, which would be the highest since 1991. Yet house prices also setting new records and shares on the London Stock Exchange the highest since the pandemic struck.

There’s the puzzle. Huge problems in the world economy, which are hitting the UK hard. Yet markets show that confidence among home buyers and investors, here and elsewhere, is solid and rising. Which matters more? 

We have some of the Chancellor’s plans already. We know taxes are going up, rising to the highest level as a proportion of GDP at least since the early-1980s. We know that National Insurance contributions are to rise from April next year. But we don’t really know much about how Government spending will be contained or increased over the rest of this parliament, and no one knows what will happen to one crucial element of public spending: what it will have to pay in interest to service the national debt. 

Questions: What on earth will Chancellor Rishi Sunak make of his upcoming Budget?

For anyone who wants to dig into the numbers, the Institute for Fiscal Studies does a thorough and independent report, called a green budget, just before the event. It came out last week. Since it runs to 428 pages, it is not ideal bedside reading. Indeed the basic message would keep you awake. 

The key points are: 

One, spending will settle at 42 per cent of national income, more than two per cent above its pre-pandemic level and its highest level in ‘normal times’ since 1985. This is more the consequences of an ageing population, than the pandemic itself. 

Two, tax increases ‘that were always inevitable have been smuggled in under cover of the pandemic’. 

Three, if the Chancellor is to get back to a budget balance on current spending, he will have to increase spending by less than he planned and ‘may even have to implement cuts to some budgets over the next two years’. 

However, there is a chink of light. There are such huge uncertainties that if things turn out better than expected, the IFS thinks that ‘it may even turn out that the £28billion package of tax rises announced in the March 2021 Budget will prove unnecessary’ and Rishi Sunak might end up reversing them or cutting other taxes. Of course, if they turn out worse something else has to give.

So what matters is what will happen to the world economy. And it is a positive view of that which is driving world markets. They are buoyed by ultra-low interest rates and the flood of money from central banks. Anyone with any sense of history will worry about that, and it may well be that we will get a sharp correction in share prices before too long. But the positive story has two powerful drivers. 

One is that technology is racing forward. Once the present disruption eases we will end up with a more robust global economic system. Indeed the disruption is forcing companies to find simpler ways of doing things. If you are struggling to find people to do a job, you try to think of ways of using fewer people. Automated warehouses save labour; cutting business travel saves the time of executives; simplifying restaurant meals saves kitchen staff time. 

The other is less obvious. It is that there is a global economic cycle. Since we have just had a monster recession, we are in the early stages of what may well prove to be a long expansion. Downturns seem to come about every ten years – the early 1980s, early 1990s, 2000s, 2009 onwards, and last year. So if this cyclical pattern holds, there could be an expansion lasting most of this decade. 

It won’t be a straight line. The world does not work like that. But I think the markets are focusing on this long view. Indeed, their current optimism only makes sense if they are. 

Come back to Rishi Sunak’s dilemma. This bumpy autumn will cost the Government money. Tax revenues, which have been very solid, will take a hit. If we can’t buy goods, VAT revenues suffer. If companies cannot fill jobs, that is less income tax and National Insurance paid to the Treasury. 

But the Chancellor would be wrong to base policy on short-term disruption. If the markets are right and this is a multi-year expansion, the numbers will look much better in a couple of years’ time.

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