OBR’s dire projections are still too optimistic

Linda J. Dodson

Britain is on track for an economic crunch not seen in living memory. GDP could fall by more than a third in the coming months, according to the Office for Budget Responsibility.

Yet hard though it may be to believe, the the spending watchdog’s numbers might not be gloomy enough.

A precise forecast is difficult at the best of times and pretty much impossible now.

The OBR has sensibly not sought to carry out a forecast, but instead produced a “reference scenario”, explaining what it believes the effect of a three-month lockdown would be on the economy.

Its results show a crunch far beyond anything seen in the financial crisis.

This may be too downbeat. Officials cite other forecasts that are much less severe, ranging from a fall of 2.1pc – in line with the worst quarter of the financial crisis – to a contraction of 26pc, which looked extreme until the OBR’s figures.

That is in part because it is based on a three-month lockdown, which is longer than some think is likely.

However, there are reasons to think the OBR is too optimistic in other ways. It has deliberately focused on the short-term impact, and not yet looked at the longer-term. That means its scenario effectively defaults to a rapid rebound in the economy.

This is the Government’s hope, with grants to businesses and a furlough scheme for workers aimed at preserving chunks of the economy. 

However, the OBR anticipates effectively a hit to GDP lasting for one year only and then sees the economy rebounding vigorously so it is just as big in 2021 as it would have been without the virus. This seems unlikely.

Some closed businesses will never re-open. Some investment will have been cancelled never to return. Global travel will suffer long after the lockdown.

The International Monetary Fund doubts the recovery will be quick this year or in 2021.

It does not expect developed economies to recover their lost ground by the end of next year. Instead it sees trillions of dollars worth of GDP effectively lost for good globally, leaving a long-term hole in the economy versus its old trajectory.

The IMF also has a warning on government spending. Rather than a one-off borrowing spree to get through the crash, the IMF is urging governments to supercharge the recovery with extra stimulus once the pandemic passes.

Even after the lockdown is lifted, nervous businesses may hold back spending. Worried families will be sensibly tempted to rebuild their savings. The Government will be tempted to step in to boost demand with its own spending instead, geeing up GDP and generating jobs, all of which costs money and probably more borrowing too – at least in the short-term.

The IMF suggests “public infrastructure investment or across-the-board tax cuts” as two possible options. It means the national debt could peak well above the 100pc of GDP predicted in the OBR’s scenario, and remain there for longer.

If and when the recovery is re-established, a rethink will be on the cards. Should the big state remain forever? Extra spending on the health service is almost certain to remain, on top of the budget increases granted in recent years.

But beyond that, the Chancellor will have tougher choices to make. The Government is unlikely to want to sustain a national debt of more than 100pc of GDP forever. Higher debts mean more interest payments, and give the authorities less room to respond to any future recession or pandemic.

Chancellor Rishi Sunak has acknowledged the challenge. He cites the need to “right the ship” once this crisis is over. It is a phrase he used in March when unveiling support for the self-employed, saying they would need to chip in to help with this in future – indicating more taxes are on the way for this group of workers.

Now he has applied it to the whole economy, along with renewed promises to “level up” the nation and spend more on infrastructure.

To use an older Conservative metaphor, when the sun is shining again, the roof will need to be fixed, again. The latest pledges from the Chancellor point to higher taxes to get that done.

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