In Defence of the OBR
The Treasury should not be marking its own homework
It was encouraging to see that the Office for Budget Responsibility (OBR) has outlined what it has learnt in terms of forecasting economic growth through a number of unprecedented crises. The OBR has also set out the changes it has made and the reforms it will make to help improve its forecasting.
This is incredibly important as the forecasts from bodies such as the OBR, ONS, and the Bank of England really do matter. Investment decisions and public policies are made off the back of these forecasts and they sometimes even help to bring down governments. As such, it’s crucially important that we get it right.
Transparency and a determination to improve are also important. It is the only way markets – and the public – can have full confidence in these institutions and their assessments of the state of the economy.
However, I worry that this risks the OBR facing unfair criticism. What follows is an edited and updated post from February on why I think most of the criticism of the OBR is unwarranted.
The OBR has come in for some criticism over the past year. Former Prime Minister Liz Truss has claimed that it understates the benefits of tax cuts and will be using her ‘Growth Commission Budget’ to challenge the modelling and forecasting of the OBR. It has also come under attack from media and economic commentators.
While the OBR is far from perfect, these attacks are unfounded and unfair.
It’s important to remember why the OBR was set up. It was established by Conservative Chancellor George Osborne to ensure that government forecasts were impartial and to improve accuracy. The issue during the time of New Labour and before was that forecasts were carried out in house by the Treasury and with a great deal of interference. Although no doubt the officials in the Treasury were no doubt striving for impartiality, that is easier said than done with Gordon Brown looming over your spreadsheet. As such, forecasts were overly optimistic which meant that tax receipts were lower and borrowing was higher than expected.
The OBR was designed to prevent this from happening. Essentially it is there to stop the Treasury from marking its own homework. It’s obviously important for the government to have an accurate view of what its tax and spend policies will actually achieve so that it can plan accordingly. It’s also a good thing that the public and businesses know what to expect from the upcoming fiscal year so they can arrange their affairs. Perhaps most importantly, it gives the government credibility and inspires confidence that its plans are serious and workable. We saw what happened with the market meltdown over the Truss-Kwarteng mini-budget which did not have an accompanying OBR forecast. The markets simply didn’t trust the government’s plans.
Rachel Reeves is right to pledge to strengthen the power of the OBR if she becomes Chancellor given its importance in keeping the government accountable while also guiding investment decisions.
However, Labour should go even further by reforming the Board of Trade. A truly independent Board of Trade with experts given the freedom to undertake blue sky thinking and develop innovative policies while also having an analysis and forecasting function which will allow it to accurately assess the impact of the government’s trade policies.
How good has the OBR been at doing its job? We have partially answered that already. The fact that markets felt that the government had sidelined the OBR and were spooked by this demonstrates just how highly the OBR is regarded by markets. I’m not saying that the reaction to the mini-budget would have been different if the OBR had been allowed to produce a forecast but things probably wouldn’t have been quite as bad. It’s also respected by institutions such as the OECD and IMF for its impartiality and accuracy.
The OBR probably does err on the side of caution when it comes to its forecasts but this is no bad thing. It is surely preferable to overly optimistic forecasts which can lead to irresponsible and reckless policy making. Moreover, the forecasts from the OBR are much more accurate than the ones which used to be produced by the Treasury.
What of the claim that it is too orthodox? Again, I’m not convinced that this is any bad thing. I have been critical of ‘Treasury Brain’ before and I think we do need to move away from letting the bean counters stand in the way of projects and policies which will bring growth. However, this is different from dismissing sound economics as ‘orthodoxy’. Truss might claim that she was brought down by economic orthodoxy, but in fact she was actually brought down by economic reality.
It’s probably beyond the scope of this post to focus on this and I’ve written about it before, but is Truss right to claim that the OBR downplays the ability of tax cuts to bring growth? It is certainly possible, and of course some tax cuts do have the potential to bring about economic growth, but many of the ones set out in the mini-budget probably wouldn’t. I bang on about this a lot but the big thing holding the UK back right now is not the tax burden but the deep seated structural issues in the economy. We need massive supply side reform to build labs, offices, nuclear power plants, wind turbines, and millions of new homes. We also need to reform childcare, open the borders, and have a closer trading relationship with the EU. This is what will unleash economic growth in the UK.
Tinkering with taxes just won’t be enough. We need a review of the entire tax system. Taxes need to be simplified and incentivise hard work and investment. This would be more pro-growth and would probably be revenue increasing at the same time.
There will always be room for improvement when it comes to improving forecasting. It can be difficult to analyse the economy and measure things such as growth in normal times, and the last few years have been anything but normal. What is more, organisations such as the OBR and the ONS have performed relatively well but it is encouraging to see that there is a commitment to get even better.