Autumn statements come and go. Like comets, they blaze across the political sky for a couple of weeks in November and December before disappearing into the inky darkness. By Christmas, they are largely forgotten.
This year will be different. For once, it matters what the Treasury cooks up and what would have been a rather mundane affair had George Osborne remained chancellor has become a very big deal indeed.
Philip Hammond is the new occupant of 11 Downing Street and he has some big calls to make. Is the economy in need of a post-Brexit boost? If it is, can the job be left solely to the Bank of England? If not, can the Treasury take up the baton and at what cost to the public finances? If so, should the stimulus come from lower taxes or higher spending?
The answer to the first question is yes. Growth in the second quarterwas reasonably robust at 0.6%, and the indicators since the referendum on 23 June have shown that the economy has held up better than most people anticipated.
In part, though, that has been the result of policy action already taken by the Bank of England and by the expectation – fostered by Hammond – that there will be more to come in the autumn statement.
Some softening in growth can be expected as a result of investment decisions being put on hold. Consumer spending appears to have held up well since Brexit, but there have been no figures yet for private capital expenditure. This was already lower in the second quarter of 2016 than a year earlier, and with uncertainty ratcheted up it is possible that there will be further weakness in the second half of the year.
The Bank of England is not best placed to cope with this. If interest rates of 0.5% for the seven years leading up to Brexit have failed to persuade companies to invest, it is hard to imagine that interest rates of 0.25% (or even 0.1%) will any more successful. Keynes called this a liquidity trap: business cannot be persuaded to invest no matter how low interest rates go. It is a classic example of the old saw: you can lead a horse to water but you can’t make it drink.
Monetary policy, which is what central banks do, is on the point of exhaustion. Indeed, there are some economists who think perpetually low interest rates and QE are the problem.
“It is not that central banks have failed to reduce interest rates enough,” said the consultancy Fathom last week, “but that the continued application of emergency monetary policy measures has held back growth in productive potential by enabling barely profitable and increasingly unproductive firms to survive. Low rates encourage zombies. Zombies do not grow.”
Apart from in the depths of the 2008-09 global slump, fiscal policy has taken a back seat. Finance ministers have sat back and left it to central banks to sort things out. This looked like a mistake in late 2009-10, when the brief flirtation with Keynesianism gave way to the vogue for austerity, and it looks like an even bigger mistake today.
There are two necessary preconditions for a Keynesian stimulus: that private sector investment is being prevented by a high degree of uncertainty, and that monetary policy is played out. Both apply in the post-Brexit world.
So, Hammond can make a strong case for an expansionary autumn statement on the grounds that there is a risk to the economy that can be dealt with better by the Treasury than by the Bank of England.
The next question is what form that stimulus should take. Hammond has two options: to cut taxes or to increase public spending, or perhaps a combination of both.
If Hammond goes down the tax route, a cut in VAT is the obvious choice. The chancellor would hope that cheaper goods and services would encourage consumer spending and so limit the risk of the economy sliding into recession. There are, though, drawbacks with this approach. For a start, it is expensive; cutting the main VAT rate from 20% to 17.5% would cost the exchequer £14bn a year. There is also no guarantee that consumers would spend the windfall; they might simply save more. And if consumer spending does increase as a result of a VAT cut, the upshot is likely to be higher imports and a bigger balance of payments deficit.
The final reason to be wary of a VAT cut is that boosting consumption is a lower priority than raising investment. And if the problem is that the private sector is not investing, it makes sense for the Treasury to boost public investment.
Some of the arguments always mustered against higher state investment can be easily countered. Hammond would not be competing against the private sector for the funds available for investment. There would be no “crowding out” if the Treasury borrowed more, because the private sector has made it abundantly clear over the past decade that it has a propensity not to invest.
Simon Wells, chief UK economist at HSBC, puts it this way: “In the current environment, the case for public investment is compelling. Interest rates can’t go any lower, uncertainty is extreme and borrowing is cheap.”
What’s more, the economy is suffering from obvious supply-side deficiencies that would be eased by higher investment: passenger numbers on the trains have doubled in the past 15 years while spending on railway infrastructure has remained flat as a share of GDP; there is no nationwide superfast broadband; there is a looming energy crisis caused by power stations reaching the end of their lives; the UK spends less on infrastructure than any G7 nation apart from the US; there is an acute shortage of new housing that is leading to excessively high property inflation and impeding labour mobility.
All in all, Hammond is spoilt for choice. Public investment is a better option for a stimulus than a VAT cut because it provides assets for the future, improves the economy’s long-term growth potential, and generates a stream of income that ensures the investment pays for itself. The deficit, currently 4% of GDP, will rise in the short term but come down over time.
Boosting public investment is not without its problems for the government. Despite all the talk about shovel-ready projects, it would take time for extra spending on infrastructure to show up in the growth figures. There are two other difficulties. One is public opposition to new railways and housing. So-called BANANAism (build absolutely nothing anywhere near anyone) is strong. The other is that the construction sector has a massive problem with skill shortages and the only realistic way to find the workers to build the new homes and lay the new tracks would be to import them from overseas.