Analysis: OBR forecast downgrade spells bad news for the UK’s finances

Pain for the UK economy means difficulty for Scotland’s public finances, writes John McLaren

Yesterday’s Budget pronouncements summed up to bad news with respect to the long-term state of the UK’s – and by implication Scotland’s – public finances.

The key change was the decision by the independent Office for Budget Responsibility (OBR) to downgrade forecasts for the growth in UK productivity.

This is important as productivity growth – the rate at which the level of output associated with one hour of work increases – is the bedrock for growth in living standards and so too in growth in real wages.

In general, employees are unlikely to be paid more if they not producing more. In the past labour productivity grew by about 2 per cent a year, which meant real wages could do likewise. However, since 2008 and the Great Recession, productivity has flatlined, as have real wages.

The OBR has consistently assumed there would be a bounce back in productivity growth to something like pre-recession levels, but this has failed to emerge. As a result, the OBR have finally decided to reduce their productivity forecasts down from an annual growth rate of 1.8 per cent, just a little below the pre-recession long-term trend of 2.1 per cent, to around 1 per cent. That is a huge change. It translates into an increase in government borrowing of over £25 billion by 2020.

On the public sector side, slower productivity and GDP growth will lead to a lower tax take and so lower government revenues, which in turn will worsen the fiscal balance and result in less scope for raising spending on public services. On the private sector side, slower productivity growth will lead to slow-to-no real wage growth, so the squeezed provision of public sector services will be accompanied by a little in the way of improving living standards.

The ultimate impact of this change, in terms of the future of public spending, is that once the Budget gets back into balance, still planned for the mid 2020s, the ‘new normal’ will involve slower growth in spending on public services than had hitherto been anticipated.

Some of the Chancellor’s major announcements involved ways of trying to improve productivity, but these are long-term measures that will take time to work, if they work at all. One of the biggest concerns over productivity is our poor understanding of why it has crashed and of how to reboot it.

All of this puts further pressure on the Scottish Government if it wants to help alleviate some long-term squeeze on public spending.

John McLaren is a political economist whose published work covers a wide range of macro and micro economic issues