2The Economy: OBR forecasting alternative scenarios
32.There has been much discussion about the size of the withdrawal settlement that the UK will pay to the EU, and the potential for a post-Brexit fiscal windfall. However, Robert Chote, Chairman of the Office for Budget Responsibility, told the Committee that the long-term impacts of exiting the EU on GDP will likely be far larger, whether positive or negative, than any policy measure within the Budget, including the size of a potential withdrawal settlement:
A one-off payment of some billions of pounds would be dwarfed by the consequences of Brexit, positive or negative, for the long-term outlook for economic growth. There is an analogy here with the time of the financial crisis. It is very easy to get very focused on the one-off or the period of particular bailout payments, whereas what matters much more is the impact on the economy and the underlying impact that has on receipts flows and spending flows.25
33.In its Economic and Fiscal Outlook November 2016, the OBR included a forecast of the impact of the decision to leave the European Union on the public finances, the main assumptions of which it has not updated since. The changes to public borrowing as forecast were summarised under the following headings:
Table 1: Changes to Government borrowing as a result of Brexit 26 27 28 29 30
|
Area of economic impact and justification for change |
Total impact on borrowing over forecast period |
|
Lower migration. “[The OBR] have used the same migration assumption as in March, so this reverses the improvement that would have been in the counterfactual”;26 Specifically, the number of migrants will be 80,000 lower than would have otherwise been the case, reducing economic growth by 0.2 percentage points per year.27 |
+ £16 billion |
|
Lower trend productivity growth. “This feeds through to weaker growth in earnings, profits and consumer spending, all of which reduce receipts. But it also feeds through to weaker growth in business investment, which boosts receipts by reducing the use of capital allowances. This effect builds steadily over the forecast period”.28 Specifically, the OBR has revised down cumulative business investment growth by 15 per cent between 2015–2020, a £27 billion reduction29 and decreased trend hourly productivity growth down from two per cent to 1.8 per cent, returning to two per cent over the next decade.30 |
+ £18.1 billion |
|
The cyclical slowdown in GDP growth. “This affects borrowing along the same channels as weaker trend productivity growth, but the effect is concentrated at the start of the forecast when we expect a negative output gap to open up”.31 Specifically, the OBR has forecast that GDP will grow by 9.7 per cent over the period, but that this is 2.3 per cent lower than it would have been were it not for the EU referendum.32 |
+ £26.2 billion |
|
Higher inflation. “After stripping out the effect of higher dollar oil prices, we [the OBR] assume that most of the remaining upward revision to inflation in this forecast is predominantly referendum-related via the weaker pound. This pushes up borrowing via debt interest, public sector pensions, those elements of welfare spending that are not subject to the uprating freeze, and the cost of indexation in the tax system. That is only partly offset by the boost to excise duties where rates rise with inflation”.33 |
+ £10.1 billion |
|
Lower interest rates. “This reduces borrowing as the beneficial effect on debt interest spending more than offsets the loss of interest income on government assets”.34 |
- £6.3 billion |
|
Other factors. “These include the fall in the pound, reduced activity in the property market, the effect on debt interest spending of the Bank’s August monetary stimulus package and the strength of the stock market, push the deficit down in most years”.35 |
- £5.7 billion |
|
Total |
£58.4 billion |
34.As part of its November 2016 forecast, the OBR created an analysis of the UK’s future share of global exports over the period up until 2025, shown in the chart below:
Figure 3: Forecast UK share of world export market share, indexed to 1998
Source: OBR Economic and Fiscal Outlook, November 2016, Chart 3.32
35.The chart does not show any significant alteration in trend once the UK leaves the EU.
36.The OBR has not produced an economic forecast incorporating what it forecasts the final end position will be regarding the UK’s economic relationship with the European Union, or the rest of the world. Its forecast states:
Given the uncertainty regarding how the Government will respond to the choices and trade-offs it faces during the negotiations, we still have no meaningful basis on which to form a judgement as to their final outcome and upon which we can then condition our forecast.36
37.The OBR is required by legislation to produce its forecasts on the basis of current Government policy (but not necessarily assuming that particular objectives will be met).37 The OBR was directed towards the Prime Minister’s Florence speech when asking whether any more policy detail existed than was in the public domain. The Government policy within the Florence speech is to achieve a “deep and special partnership with the European Union, and this should span a new economic relationship”.38
38.The OBR states that “Parliament requires us to base our forecasts solely on the Government’s stated current policies and we therefore do not consider alternative policy paths”.39 Given these constraints, the OBR has made the following assumptions in its forecast:
- The UK leaves the EU in March 2019—two years after Article 50 was invoked.
- The negotiation of new trading arrangements with the EU and others slows the pace of import and export growth over the 10 years following the referendum. This slowdown is calibrated on the basis of a range of external studies of different possible trade regimes and assumed offsetting impacts from exports and imports on GDP growth.
- The UK adopts a tighter migration regime following departure from the EU than that currently in place, but not sufficiently tight to reduce net inward migration to the desired ‘tens of thousands’.40
39.When asked if he would be in favour of the OBR producing an additional forecast of the impact of a Withdrawal Agreement, the Chancellor stated that his understanding that “the OBR’s statutory mandate is to produce two reports a year, two forecasts a year”.41 Section 4 of the Budget Responsibility and National Audit Act 2011 states that the OBR must “on at least two occasions for each financial year, prepare fiscal and economic forecasts”.42
40.Section 5 of the Budget Responsibility and National Audit Act 2011 states that “Where any Government policies are relevant to the performance of that duty, the Office—(a) must have regard to those policies, but (b) may not consider what the effect of any alternative policies would be”.43 The Charter for Budget Responsibility gives the OBR “complete discretion to independently determine the methodology by which the OBR produces its forecasts, assessments and analyses,”44 and requires the OBR to produce “an analysis of the risks surrounding the economic outlook”.45
41.The OBR uses the ONS’ migration forecasts as its input figure for migration in its economic forecast. These forecasts have been consistently above the tens of thousands, which is in contradiction to the Government’s stated policy of reducing migration to the tens of thousands.46 In its Economic and Fiscal Outlook November 2016, the OBR forecast that the impact of leaving the EU would increase Government borrowing by £58 billion over the forecast period. It has not since revisited this assessment. However, as 2018 progresses, the Committee judges that the ability to revise the November 2016 forecast is likely to be possible and the Committee recommends the OBR does so at the earliest possible opportunity.
42.The OBR has stated that it still has no meaningful basis to judge the UK’s final relationship with the EU, on which it can condition its forecast for the economy and the public finances. However, the absence in its forecasts of a step change in trade intensity at the point that the UK is expected to leave the EU (in March 2019) is consistent with a scenario where transitional arrangements are negotiated. The forecasts are not consistent with a reversion to WTO rules in March 2019, which would be likely to lead to a substantial negative trade shock from Q2 2019 onwards.
43.Although no specific attempt has been made to forecast the long-term impact of the UK’s end-state relationship with the EU, Robert Chote has acknowledged that the consequences of Brexit on economic growth, whether positive or negative, are likely to be so substantial as to dwarf the impact of the financial settlement.
44.Parliament will need to be fully informed about the size and the direction of these economic and fiscal impacts before it comes to vote on the legislation giving effect to the withdrawal agreement. The independent OBR is best placed to provide this information. It should publish an economic outlook that incorporates the terms of the Withdrawal Agreement prior to Parliament’s consideration of the planned Withdrawal Agreement and Implementation Bill. If the next scheduled forecasts, due to be published around November 2018, come either too early to incorporate the terms of the Withdrawal Agreement, or too late for Parliament’s consideration of the Bill, the OBR should prepare a special forecast. The legislation setting out the OBR’s statutory responsibilities requires the OBR to publish a minimum of two forecasts a year, but does not set an upper limit.
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26 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
27 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 3.25
28 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
29 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 3.23
30 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 3.24
31 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
32 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 3.61
33 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
34 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
35 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9346, November 2016, paragraph 1.32
36 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 3.3
37 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 3.2
38 Foreign & Commonwealth Office, Prime Minister’s Office, 10 Downing Street, Department for Exiting the European Union, ‘PM’s Florence speech: a new era of cooperation and partnership between the UK and the EU’, accessed 17 January 2018
39 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 2.24
40 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 3.3
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44 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 4.5
45 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 4.8.1
46 Conservative Party, The Conservative and Unionist Party Manifesto 2017, Page 54 & Conservative Party, The Conservative and Unionist Party Manifesto 2015, Page 29
19 January 2018