The IFS was not wrong to describe shrinking UK pay packets as dreadful

Directors of the Institute for Fiscal Studies normally avoid hyperbole. They do not tend to use words such as “dreadful” when analysing the state of the economy or the public finances.

But that was the term Paul Johnson, the head of the IFS, chose to describe the era of shrinking pay packets triggered by the financial crash of 2007-08.

Back in March, the expectation was that average earnings would finally claw their way back to their pre-crisis level by the start of the next decade. The latest forecasts from the Office for Budget Responsibility (OBR) suggest the Brexit vote means that will no longer be possible.

Real wages will still be below their 2008 level in 2021, something that Johnson said had not occurred for at least 70 years and possibly a century. A dreadful record, indeed.

He said the UK’s disastrous productivity record was the reason for the sharp drop in earnings in the five years after 2008 and the slow recovery since. Brexit is expected to be double whammy for wages. Productivity growth will be weaker and inflation higher. Real average earnings – pay packets adjusted for inflation – are expected to rise by 5% between now and 2021. That means they will be 3.7% lower in five years’ time than was predicted at the time of the budget in March.

Johnson rallied behind the OBR, which some Conservative MPs and sections of the media have accused of producing over-pessimistic forecasts. The IFS director noted that the OBR’s economic forecasts were noticeably more upbeat than the Bank of England’s.

“Earlier this month, the Bank projected growth of 1.4, 1.5 and 1.6% in 2017, 2018 and 2019 respectively. The OBR’s projections are for growth of 1.4, 1.7 and 2.1%. That’s quite a big difference,” he said.

Slower growth means higher borrowing to cover a bigger budget deficit. By 2020 and 2021, Hammond will be borrowing £32bn more than Osborne was planning, of which £18bn will be due to weaker growth. As the IFS noted, however, there were bigger changes to the borrowing forecasts when the growth disappointed in 2011 and 2012.

“The OBR put £15bn of that £18bn down to the Brexit vote”, Johnson said. “If that turns out to be the effect, that’s a somewhat smaller hit than many forecasters were suggesting.”

Even so, the fresh deterioration in the public finances means that austerity will be extended into the next parliament, assuming that an election takes place in 2020. Hammond has pledged to run a budget surplus between 2020 and 2025, but will need to raise taxes or cut spending by a further £30bn to do so, the IFS said.

Balancing the books will become more difficult over the next decade as a rising number of baby-boomer retirees means a bigger state pension bill. The IFS also wonders how long Hammond can resist the pressure for higher spending on the NHS and on social care.

By and large, though, the new tenant at 11 Downing Street got a relatively easy ride from the thinktank. Chancellors have become accustomed over the years to getting admonished by the IFS on the day after a budget or an autumn statement. A big crowd always turns up to witness it pick the Treasury’s work to pieces.

The IFS found less to complain about than usual. Sure, it tut-tutted about the freeze in fuel duties and was unhappy about the increase in inheritance premium tax, but these were minor quibbles.

It liked the fact that the chancellor had decided to dispense with the autumn statement and praised him for coming up with a package noticeably short on gimmicks. It was impressed by the increases in public investment, with Johnson noting that higher infrastructure spending will take public sector net investment to around 2.3% of GDP. That was what Labour was planning before the financial crisis broke and well above the average over the last 30 years.

“Given the choice between jam today in the form of more money in people’s pockets and jam tomorrow in the form of potential economic returns from greater investment, he went for jam tomorrow.,” he said.

That decision means the outlook for those on low and middle incomes is bleak. Osborne’s announcement in his summer 2015 budget that non-pensioner benefits would be frozen in cash terms for the entire 2015 to 2020 parliament saved the government £3bn a year, but meant 11m households were on average £280 a year worse off.

Hammond has provided a little help through changes to universal credit, but it will be more than offset by the projected impact of inflation. As a result, the 11m households now stand to lose £390 a year, saving the exchequer £4.2bn a year.

Even so, Hammond will still be borrowing 2% of national income by 2019-20. He is able to do so because he has ditched all three of the fiscal rules set by his predecessor. The IFS noted drily that the policy of borrowing to invest looked remarkably similar to that proposed by Ed Balls during the 2015 election campaign. The then shadow chancellor was proposing to balance day-to-day government spending by 2018-19, but Hammond will not even manage that.