Jeremy Beckwith: Lowering expectations can lead to greater success

A year ago, George Osborne set out his plans for getting the UK public finances on to a more secure footing. To counteract the Treasury’s longstanding record of over-optimism in forecasting trends in the UK economy, he set up the Office for Budget Responsibility (OBR) as an independent body to give greater credibility to his plans, believing that they would adopt a less rosy view of the world.

Then he went further and gave himself a target of eliminating the structural budget deficit in five years, but his actual plans were forecast to achieve this in four years. His aim in all this was to maximise the expectation of the pain required in his deficit reduction plan and so minimise his chances of his plan not achieving their goals by the time of the next election.

He was trying very hard to ensure that the economy and the reduction in the budget deficit actually came in better than expected in the later years of this Parliament, leaving him some scope for reining back on spending cuts or cutting taxes just before the May 2015 election.

The last year has not been kind to him. First the performance of the global economy has been much worse than was expected a year ago – this is not just the result of the mess in Europe, but also much weaker growth in the US and high food price inflation in many developing economies forcing them to slow their economies by raising interest rates – and this has contributed to a weaker than expected UK economy, making the job of reducing the deficit even more difficult. Second, the OBR made some key assumptions in its work that in hindsight were still too optimistic. They took the view that much of the reduction in tax revenues suffered in 2009 and 2010 was cyclical and thus short term rather than structural and so long term. Thus, they had tax revenues recovering quite sharply once growth got going again. This year’s deficit forecast is close to target, because there was little growth expected But the deficit forecasts for the next few years have had to be increased to account for weaker world growth, and the OBR’s recognition that tax revenues from the banking system will not bounce back as fast due to the ongoing crisis and that weak productivity growth is likely to mean a slower rate of reduction in the jobless rate.

In his first year then, Osborne has not been seen as a success because he has had to reset expectations to an even lower level. From here though, it might just work out well for him. First, both he and Mervyn King have explicitly stated that all forecasts are dependent on the eurozone crisis being resolved fairly quickly, which is not unreasonable, and, second, that this time it could well be that the OBR’s assumptions are too pessimistic, in that they now assume that the loss of tax revenues were structural and long term and not at all cyclical and short term.

Osborne now has more pessimistic forecasts, for which he is criticised today, but which give him a greater capacity to produce a positive surprise, for which he can take credit, in a few years time.

For David Cameron, the bad luck may not be so easy to turn around. A successful resolution of the eurozone crisis requires much greater co-ordination of fiscal policy across the eurozone. This will require tighter rules and international bodies with real power – in other words deeper political union.

The UK’s economic interests are clearly best served by a resolution of the crisis, but such a resolution is not, from a Conservative perspective, in the UK’s foreign policy interests.

It re-opens the European faultline within the Conservative Party, which Cameron has worked so hard to paper over. The UK will have to make a fundamental reassessment of its policy towards Europe if the euro survives and a deeper political union results.

Such a debate has always proved to be very damaging for the Conservative Party.

• Jeremy Beckwith is an independent economist and investment manager.