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Labour’s plan: more debt with little growth benefit

    ‘Reckless, ideological cuts’ the Labour benches holler. ‘Dealing with the nation’s debts’ claim the Coalition ministers. It’s easy to forget that their public commitments going into the last election were remarkably similar. The Labour government’s plan was to halve the deficit (the OVERALL deficit) in four years – which their own manifesto showed to mean cutting the structural deficit by two-thirds. The Conservative party meanwhile committed merely to eliminate the bulk of the structural deficit. Spot the difference? I couldn’t.

    Once in office, the Coalition laid out spending and tax plans to eliminate the current structural deficit during the Parliament. Since then, growth forecasts have changed dramatically – primarily, according to the OBR, because of external factors like high commodity prices, the Eurozone crisis and the bust being bigger than originally thought. Now, the Government’s deficit, current structural deficit and debt forecasts for the end of the Parliament are worse than Labour’s 2010 forecasts. The Coalition, rather than re-opening tax and spending decisions, have stuck to their spending plans and now will not meet their deficit reduction mandate until well into the next Parliament.

    Labour has always argued that the cuts over the past two years have played a large part in causing the slower than planned growth, despite the IFS and OBR claiming otherwise. Ed Balls and co. frequent our televisions with their ‘plan for jobs and growth’.

    How different would the past few years have been economically under a Labour administration? It is of course impossible to say whether Labour would have stuck to its pre-election plan after the election. But the Ernst&Young ITEM club have given the closest thing we have to a counterfactual (an idea of the excellent David Smith of the Sunday Times). Using their model, the same as the Treasury’s, they have attempted to work out the macroeconomic impact of sticking to Labour’s fiscal plans between 2010 and 2012.

    They ran three separate simulations, the first of which includes all of the Coalition’s planned austerity measures as a baseline. They ran two scenarios under a Labour administration:

    • The first Labour scenario (Labour 1) uses the fiscal plans the Coalition inherited for 2010-2012. The main features of this are reversing the VAT rise and the Corporation tax cuts, as well as adjusting the spending totals in line with the difference between the Coalition’s 2010 Emergency Budget forecast and the Labour 2010 Budget forecast.
    • The second Labour scenario (Labour 2) assumes the same as Labour 1 but with an assumption that a government running looser fiscal policy would pay a premium in terms of gilt yields. This scenario assumes that gilt yields would be 50 basis points higher, which is equivalent to the decline in gilt yields between the last Labour Budget of March 2010 and the emergency Budget of June 2010.

    What are the results of these different scenarios on growth, unemployment, borrowing and debt?

    Growth and borrowing/debt

    As the chart above shows, the model suggests a looser fiscal policy as proposed by Labour would have had little effect on real GDP growth. The Coalition baseline case in the model shows growth of 2.1% in 2010, 0.7% in 2011 and 0.4% forecast for 2012.

    Under Labour 1, where there is no change in gilt yields, growth would have been marginally higher in 2011, by 0.1 percentage points, and in 2012, by 0.4 percentage points, but lower in 2010 by 0.1 percentage points. This small amount of extra growth overall would have come at the cost of a budget deficit £11.7 billion higher in 2011 and £5.5 billion higher in 2012 (6.2% of GDP rather than 5.8% of GDP) compared to the Coalition baseline and with an increase in debt across the three years of £20.2 billion.

    Under Labour 2, where the gilt yield assumption is included, the uplift in growth under Labour’s plan is smaller still. Growth is put at 2% in 2010, 0.7% in 2011 and 0.7% in 2012 (0.1 percentage points down, the same, and 0.3 percentage points up on the Coalition baseline case). This even smaller amount of extra growth would come at the cost of a budget deficit £13.5 billion higher in 2011 and £8.2 billion higher in 2012 (6.4% of GDP compared to 5.8% of GDP) than under the Coalition and with an increase in debt across the three years of £26 billion.

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    Unemployment

    How many people would be back in work if the government had followed Labour’s tax and spending plans?

    The results from the ITEM club forecast suggest that in 2010 unemployment would have been almost exactly the same in all three scenarios. In 2011, unemployment would have been very slightly higher under Labour 2 compared to baseline by 9,000, and lower by around 18,000 jobs in Labour 1. By 2012, unemployment would be slightly lower in both Labour scenarios by 129,000 in Labour 1 but only 70,000 in the more realistic Labour 2 compared with the baseline. There would, however, have been £26 billion of extra public borrowing over the three year period under Labour 2.

    Conclusion

    Unsurprisingly, the ITEM club’s forecasts suggest that the Labour party would not have lowered the deficit as quickly as the Coalition without any of the additional measures the Coalition has implemented. The modelling shows that the spending cuts and tax rises seen so far have reduced the deficit compared to both Labour counterfactual scenarios – negating Labour’s argument that trying to cut less quickly would have led to better deficit outcomes. Furthermore, the similarity in real GDP growth under the baseline and more realistic Labour 2 scenario shows that spending cuts and tax increases so far are not to blame for slow growth since 2010. Under the Labour 2 scenario where gilt yields are 50bp higher, implementation of Labour’s policies would have seen only around 70,000 fewer people unemployed by 2012 but at a cost of £26 billion added to the public sector debt since 2010. That’s a cost of around £370,000 per job, with the increased debt burden to be dealt with later.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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    Comments

    Archimedes Syracuse - About 2539 days ago

    The gist of this blog, then, is that things are no worse under the Conservatives? Tell me why we voted Conservative again?

    The reduction in the unemployment figures seems like a worthy recipient of £26bn to me, unless the Conservatives can prove they can bring down the unemployment figures faster once they've made it through the bulk of the fiscal adjustment.

    The balance of this blog seems to suggest to me that Labour's judgement on the fiscal side was better. This is acceptable to a degree, given that Labour had access to the fuller figures, being in government at the time they made their budget. However, it only remains acceptable if the Conservatives adjust their fiscal plans to attain better trajectories on all four of those graphs.

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