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The OBR forecasts and assumptions show the scale of our fiscal challenge

    Each year, the Office for Budget Responsibility publishes a 50-year forecast in order to gauge the long-term sustainability of the UK public finances. I know, I know. Given how accurate our five year forecasts are, a 50 year forecast is little more than an exercise in mental masturbation. But I do think the figures they come up with are instructive of the scale of the pressure we could face in terms of our debt burden and the potential impact of an ageing population.

    The OBR’s central message is quite clear: on unchanged policies (i.e. without discretionary changes to tax and spending after 2017/18), the demographic changes to the population would put the public finances on an unsustainable trajectory.

    Take Table 3.10 from that report. It forecasts that total managed expenditure would rise from 40.5% of GDP in 2017/18 to 45.5% in 2062/63. Given tax revenues remain fairly stable as a proportion of GDP, this means public sector net borrowing is forecast to increase from a low of 0.8% of GDP in 2022/23 to 5.8% of GDP in 2062/63, with debt then rising exponentially.

    Under its central projection, health spending is forecast to increase from 7% of GDP in 2017/18 to 8.8% in 2062/63, state pension spending to increase from 5.4% to 8.4% and long-term social care spending to rise from 1.3% to 2.4%. According to the OBR then, the government would need to cut spending or raise taxes permanently by around 1.9% of GDP from 2018/19 (on top of the existing planned consolidation measures) so that it was able to raise enough revenue to fund non-interest spending and pay off debt over an infinite horizon. Another way of looking at it – if the government wanted to get debt down to 40% of GDP by 2062/63, they’d have to close the gap between spending and taxes by a further 1.2% of GDP.

    Now, this in itself shows the upward pressure on spending due to an ageing population. If the government wanted to keep health, pension and care funding arrangements the same, it would have to cut deeper into other things. And this is assuming, remember, that it has already implemented all the cuts to 2017/18. If paid through taxes, it would mean a higher burden on an increasingly shrinking (in relative terms) working-age population.

    But looking at some of the assumptions the OBR makes for its central case, there are plenty of reasons to think the situation could be worse still.

    The OBR assumes, for example, that productivity growth will return to the same trend as seen between 1971 and 2008 (2.2% per year). Yet some economists, such as HSBC’s Stephen King and former MPC member Andrew Sentence, believe that we are now in a new normal where the underlying growth potential of the economy has fallen. If this is the case and productivity growth was lower (at, say, 1.7%), then debt would be forecast to rise to 135% of GDP by 2062/63 instead of 99%.

    The OBR also assumes a set path for interest rates, with the long-term projection of the gilt rate at 5%. As the chart below shows, however, our long-term debt outlook is extremely sensitive to this assumption.

    But perhaps the most worrying and heroic assumption of all is that the OBR’s central case models health sector productivity to improve at the same rate as the rest of the economy. This, for anyone who has studied Baumol’s Cost Disease or seen recent health productivity data, looks, shall we say, “unlikely”. And this turns out to be a particularly key assumption in the whole forecast. If health productivity growth was 1% per year rather than 2.2% per year (which, incidentally, still looks optimistic given recent trends) then debt would explode to 211% of GDP by 2062/63.

    That’s because health spending as a proportion of GDP would rise to from 8.1% of GDP now to 14.5% of GDP in fifty years.

    None of this is certain. It might be that there are huge technological advances which facilitate the realisation of huge productivity gains in healthcare, for example. But I just think that given the assumptions made and the outlook even on these assumptions, the OBR forecasts are quite frightening. I haven’t changed my mind since my Cambridge debate below (I start at 29:16) – given the outlook, I believe the welfare state in its current form is unsustainable.  We are still fighting through a programme to get our debt on a downward path, and have a demographic time-bomb around the corner. Continuing with the same scope of the state over a long period will either lead to much higher taxes, much lower spending on the liberal functions of government or much higher debt. The sooner we start facing up to these long-term challenges, the better. 

     

    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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