The best-case scenario for the UK economy is still bleak

Box of tricks.
Box of tricks.
Image: REUTERS/Henry Nicholls
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Earlier this week, British chancellor Philip Hammond delivered the UK’s final budget before it exits the European Union. Hammond went to lengths to try and paint a picture of a bright future after Brexit, with a smattering of spending giveaways for schools, road repairs, and taxpayers. He also got a blessing from the Office for Budget Responsibility (OBR), the independent group that provide the economic forecasts (pdf) that the Treasury bases its budget on. The OBR upgraded its forecast for UK GDP growth next year to 1.6%, up from a 1.2% forecast it made in March.

However, this upgrade should be considered the context of what the OBR expected before the UK voted for Brexit. Forecasts from March 2016 (pdf), just three months before the referendum, predicted annual economic growth of about 2% for several years. This week’s forecasts are a significant downgrade from those expectations.

Importantly, these forecasts are based on the assumption that the UK will exit the EU smoothly, reaching a deal on its future trading relationship with the bloc. They are, in other words, the best-case scenario forecasts. The OBR, required to use current government policy as the basis of its forecasts, assumes “an orderly transition to a new long-term relationship” between the UK and the EU. This is looking increasingly uncertain as the March 2019 exit date approaches with major hurdles still obstructing a deal.

The budget was held several weeks earlier than usual, most likely to avoid clashes with key Brexit talks, particularly a special summit that was arranged for mid-November with the hopes of wrapping up negotiations. Instead, that summit has been scrapped because talks aren’t progressing fast enough. Now, there are reports that Brussels is preparing for a summit to consider the increasing likeliness of a “no-deal” Brexit. There’s still a summit scheduled for December among EU leaders that could wrap up a deal, but even this may not leave enough time for it to be ratified by British and European parliaments (paywall) before March.

Hammond’s budget could be wiped away if there is no deal. The OBR said that a disorderly exit “could have severe short-term implications for the economy, the exchange rate, asset prices and the public finances. The scale would be very hard to predict, given the lack of precedent.”

S&P Global Ratings said this week that a no-deal Brexit could push the UK into a “moderate recession,” a risk the agency believes has substantially increased. In that case, the UK economy would contract in 2019 and 2020 before returning to anemic pace of growth, S&P said, with unemployment rising to levels last seen during the financial crisis and house prices tumbling by 10%.

Meanwhile, British prime minister Theresa May remains determined to prove that Brexit can make the UK a more prosperous place. She went as far as declaring the “end of austerity,” in reference to eight years of spending cuts imposed by her party, which have severely damaged living standards in the UK (pdf).

Hammond’s optimistic budget does not end austerity. The chancellor himself avoided the prime minister’s promise with a noticeable change of language: “the era of austerity is finally coming to an end.” (Not austerity “is over,” as May said.)

Hammond’s claim allows for backtracking, and is also made possible because of the improved forecasts for public finances by the OBR. Next year, after Brexit, these forecasts could significantly deteriorate, said the Institute for Fiscal Studies (pdf), the UK’s leading watchdog on the subject. In fact, there’s a one in three chance of that happening, the IFS warned.

Hammond said he is opening a new chapter in the UK’s economic history and, indeed, on the face of it, this budget represents a significant change in the Conservative party’s approach to public spending. Instead of spending per capita falling almost 6% from its 2015-16 level by 2022-23, as proposed earlier this year, it will rise by 2% in the latest budget.

Almost all of that extra spending will go to the National Health Service. While the money will be welcomed by the underfunded service, it will still leave other government departments facing flat spending or cuts. Again, this is not the end of austerity.

“The Chancellor’s numbers imply ongoing cuts in other day-to-day public services, from prisons to local government,” said the Resolution Foundation (pdf), a UK think tank.

Public service spending, excluding health, is 19% lower today than it was in 2010-11 and will stay flat for the next five years, the IFS calculates (pdf). Even including the extra £20 billion in healthcare spending, the austerity inflicted during this decade won’t be undone. Total public spending is 8% lower today than in 2010. There has never been a decade like this before, said Paul Johnson, the director of the IFS.

“Many public services are going to feel squeezed for some time to come,” he said. “Cuts are not about to be reversed. If I were a prison governor, a local authority chief executive or a headteacher I would struggle to find much to celebrate.”

On top of this, there are still £4 billion in welfare cuts that are still working their way through the system.

Hammond’s hope that Brexit will not only go smoothly, but result in a “double deal dividend” for the British economy has raised eyebrows. While he can use some of the £15 billion he’s holding in reserve should Britain crash out of the EU in a messy way, the possibility that a good deal will lead to a meaningful economic boost seems remote, given that the OBR’s rather subdued forecasts already incorporate a smooth Brexit.

It’s now five months until Brexit becomes official, and the government’s belief that the divorce won’t make the UK poorer remains unconvincing.