The coronavirus outbreak made the Office for Budget Responsibility’s latest forecasts for the UK economy obsolete even before they went to the printers.
When the fiscal watchdog finalised its figures in February, it thought the UK’s economic outlook looked gloomier than a year ago. Weaker global GDP and trade would weigh on UK economic growth in the near term, while in later years the OBR thought productivity growth would be worse than it had previously assumed, limiting the economy’s sustainable rate of expansion.
The government’s fiscal stimulus will pump GDP growth up above the rate that is sustainable in the longer-term, the forecasts suggest.
The OBR said government spending would account for more than half of the expansion in output this year and next, with GDP growth rising from 1.1 per cent in 2020 to 1.8 per cent in 2021 as the fiscal expansion reached its peak — but settling at an average of 1.4 per cent in the medium term.
This is an extremely weak outlook. The Resolution Foundation, a think-tank, noted that the forecast for cumulative GDP growth of just 7.3 per cent over five years was “nearly a quarter below that seen during the sluggish post-crisis decade”.
But these forecasts have been overtaken by events. Robert Chote, the OBR’s chairman, said that given the spread and severity of the coronavirus, the downside risks to the forecast were now “all too clear”, even though it was still impossible to quantify their scale and duration.
“With lots of people potentially sick — or limiting their movements to avoid becoming so — the virus is likely to depress both demand for goods and services and the ability of businesses at home and abroad to supply them,” he said, adding that the disruption “should be temporary unless it inflicts lasting damage on the economy’s supply capacity — as the financial crisis did”.
The Resolution Foundation said that an inevitable coronavirus-related downgrade to growth even of just 0.2 percentage points this year “would make this the weakest official five year-growth outlook ever published”.
This means the UK’s fortunes over the next year and beyond will be even more reliant on government largesse.
Rishi Sunak made much of the OBR’s judgment that his spending plans would add 0.5 percentage points to growth over the next two years — even before factoring in the extra measures he announced to counter the impact of the virus.
He also cited the OBR’s estimate that his investment plans could eventually increase the size of the economy by around 2.5 per cent if future governments maintained the same level of capital spending, saying: “The OBR have confidence in the long-term future of our economy — and so do I.”
But Mr Chote described the short-term boost from fiscal stimulus as “a bit of a sugar rush”. He made it clear that long-term gains would not show up within the OBR’s five-year forecast horizon, and were far from guaranteed since they would depend on higher capital spending being sustained indefinitely — “which history admittedly suggests is unlikely”.
The OBR predicts that GDP growth will settle at an average of 1.4 per cent in the medium term, constrained by the weaker outlook for productivity and by the lower population growth implied by the government’s plans for a tighter post-Brexit immigration regime.
One of the OBR’s main messages was that even if the UK saw the full benefits of the government’s infrastructure drive, this would not be enough to offset the negative effects of Brexit.
With a smooth transition to a typical free trade agreement, Brexit would leave UK productivity 4 per cent lower in 15 years’ time than it would otherwise have been, the OBR said.
It estimates that around a third of this long-term damage has already been done, with productivity growth depressed both by the prolonged post-referendum slump in business investment and by the diversion of resources away from more productive activity into no-deal contingency planning.
Although Brexit uncertainty was now starting to dissipate, the effects of new trade barriers on productivity would increasingly come into play, the OBR said, predicting that a further third of the hit to productivity would be felt over the next five years, with the remaining third to follow after.
On top of this drop in productivity, planned changes to the UK’s immigration regime could cut UK potential output by 1.2 per cent, the OBR said — meaning that Brexit would leave the UK economy 5.2 per cent smaller than it would otherwise have been.
The OBR has repeatedly proved over-optimistic in its forecasts for the UK’s potential productivity growth — the key determinant of long-run living standards and wages. Although it has again revised down its assumptions, it remains more optimistic than the Bank of England on the medium-term outlook for both productivity and growth.
“The OBR is clinging to the view that productivity growth will rise from the dead,” wrote Samuel Tombs at the consultancy Pantheon Macroeconomics, adding that the watchdog’s optimism had allowed Mr Sunak to plan a huge increase in expenditure while still meeting the government’s main manifesto pledges on fiscal responsibility.
