He is only 39 years old. His mannerisms have come in for much criticism as his mouth curls up in disdain whenever he speaks with someone. George Osborne is a scion of a privileged family much like his friend David Cameron, the Prime Minister. Faced with a huge deficit, many expected from him a return to the bad days of Margaret Thatcher.
The Conservative Party had promised that if they won the elections there would be a budget to tackle the double-digit Budget deficit, which the Labour Party was about to leave behind. There had been a small element of Budget deficit between 2002 and 2007 when there was sustained growth and full employment. Gordon Brown had broken the rules he had set himself, of borrowing only for investment and maintaining a stable debt-GDP ratio. The debt-GDP ratio went up from a low level of 39% in 2001-02 to 48% by 2006-07. When recession hit, the countercyclical spending added to the burden so that the debt-GDP ratio went up to high figures in the 70s. While the case for countercyclical reflation is obvious, Britain had a structural deficit, which was acquired before the recession and has now been estimated at 7% of GDP of the total deficit of 11%.
There was a keen debate on the timing of the cuts as well as their size. In its last Budget, the outgoing government had laid down a path of deficit reduction that was to start gently in 2010-11, if at all, then leave the economy with about 3% deficit by 2015-16. The Keynesians were arguing for a continued stimulus to compensate for the lost output of around 5% during the recession. They would have preferred delaying the reduction in deficit until much later. Labour had compromised by beginning the cutting later and not eliminating the deficit completely within one parliament.
Some economists (myself included) took the view that this was too risky. The structural deficit could not be eliminated without a special effort, and the indebted position of western governments, in general, was too precarious to expect the markets to stay calm. The debt crisis in Greece and generally in the euro zone added some weight to this idea. George Osborne as the prospective chancellor of the exchequer had committed himself to a drastic path, of eliminating the structural deficit within the parliament i.e., by 2015.
The Budget he delivered on June 22 has done just that. But this has been done with some shrewdness. Since the government is a coalition and the Liberal Democrats are soft on budgetary discipline, the chancellor had to be shrewd. He has solved the problem by freezing the current spending totals??640 billion or about 45% of GDP?in real terms for the next five years. He did not explicitly say this but he has shaved-off the slight increase pencilled in by Labour in its last Budget for the five years from 2010 to 2015. He has done this mainly by freezing the public sector pay of all employees who make more than ?21,000 for two years ahead (but granted a flat increase of ?250 to all below that limit), raising the VAT from 17.5% to 20% from January 2011 onwards, and extending the capital gains tax that Labour had cut to 18% to a higher band of 28%. He also froze child benefits for three years ahead and restricted the child tax credits to families earning less than the upper limits of income where the tax rate goes up to 40% from the 20% base. In addition, banks will pay a levy that will net the government ?2 billion.
But at the same time there are sweeteners to please the Lib Dems. He raised the minimum threshold of income tax by ?1,000, taking around a million low earners out of the net of taxation, promised to link state pension growth to 2.5% each year or higher, if inflation or earnings growth exceeded that limit. He has promised to cut corporation tax by one percentage point each year for the next four years.
The likely impact of these changes is going to be debated for some time. One of the innovations the government adopted was to have an independent Office of Budget Responsibility (OBR), which publishes growth and deficit forecasts that the government has to accept. The OBR had published its first report a week before the Budget and traced out the growth path, taking into account the last government?s Budget. Growth was pegged at 1.7% in 2010-11 and then at 2.7% 2011 onwards. This was lower than the 3.5% growth in 2011 that the last Labour Budget of March 2010 had predicted. The OBR took the view that those forecasts were too optimistic and the deficit projections were too cautious. The OBR has issued a new report after the Budget, which shaves down the growth rate of GDP to 2.6% next year but then resumes its earlier estimates of 2.8/2.9%. The OBR also claims that there will be no adverse effects of the Budget on employment. These forecasts remain to be tested.
The Budget is politically clever because many of the cuts in spending are achieved by freezing current payments or indexing them at a lower rate or postponing the annual increases. Government investment has not been touched at all. Keynesians are still wary and there will be loud complaints about the cuts. Yet it seems that the deficit is now being taken under control. Unless there is a double-dip recession, thanks to the breakdown in the euro zone, the Osborne gamble may just pay off.
The author is a prominent economist and Labour peer
