Soaraway unsustainability ….

The Office for Budget Responsibility (OBR) published its latest Fiscal Sustainability Report (FSR) last month on 17 January. This was met with none of the usual media fanfare as it coincided with the Prime Minister’s Brexit speech which exhausted the day’s stock of screaming headlines. These reports are usually published annually in July, but last year’s was put off until the immediate referendum dust had settled, so this is the first report since July 2015.

As in every previous report back to the first one in 2011, the OBR conclude that UK public finances are on an unsustainable course. A key measure of sustainability is the ratio of public sector net debt (PSND) to gross domestic product (GDP). While the OBR says that there is no consensus on what would be an optimal level for the public debt to GDP ratio they calculate the fiscal tightening necessary to return PSND to 20, 40 or 60 per cent of GDP at the end of their projections in 2066–67. That implies that 60% is seen as about the upper limit of sustainability. The current ratio of 87% is well above anything seen in previous decades because of the large deficits run up in each year since the Great Financial Crash in 2008.

Before the crash, the debt/GDP ratio had been around 40% and in its last FSR in 2015, the OBR was projecting that the ratio would be quickly brought down to below 60% in 2026. However, a bare eighteen months later it is projecting that the ratio will shrink by a mere 10 percentage points over the next ten years, and whereas they had previously projected a slow rise back to present levels by 2060, they are now projecting the debt/GDP ratio to be a whopping 200% by then, and 233% five years later. As the previous projection was itself said to be unsustainable, the new one is super-plus-unsustainable.

How can finances have deteriorated so quickly? Surely it’s Brexit!! Well no it isn’t, the OBR have not yet made any adjustments for what a post-Brexit world might be like because no one yet knows the basis of our future relationship with the EU or the rest of the world. Instead, two key reasons are firstly a higher starting point for the debt/GDP ratio as George Osborne did not bring debt down as quickly as he had hoped, but secondly and more importantly the OBR are assuming that health costs will rise much more than they had previously. Health spending had been projected to rise significantly in previous forecasts in line with a growing and ageing population but only on the basis that health spending is concentrated on the elderly, and so the projected increase was largely compositional, more spending being caused by more oldsters. However, in their latest projections they now assume, in line with forecasting practice elsewhere in the world, that there will additionally be rises in the price and prevalence of health treatment i.e. medical advances will mean more treatment (and often expensive treatment) at all ages.

The BBC series “Hospital” that’s running at the moment has some great examples of this. For example in Episode 5, 18 year-old Deborah is saved because new developments mean that sickle-cell disease can be cured with a bone-marrow transplant from a donor who is only a 50% match rather than as previously requiring a 100% match. This means that of all the young people with sickle-cell, more can now be treated and will be treated, pushing up spending. Though the state can put into the other side of the balance the prospect of a healthy tax-paying life for Deborah! At the other end of the age-spectrum, the programme showed new procedures for heart-valve replacement for people who are too old and frail for traditional open-heart surgery, increasing the proportion of people within an already increasing pool who can be treated (and thus doubly increasing the number of operations that could take place). One might think that there isn’t much benefit from operating on 86 or 98 year-olds as their tax-paying years are behind them, but as one of the doctors pointed out, it’s cheaper to do the operation rather than wait for someone to keel over with a heart attack and then have them occupying a bed as an emergency case from which they will probably not recover. In that case the spending would be all too literally a dead loss. The whole series is well worth watching.

Back to the OBR though, while they are putting increasing costs onto one side of the balance they are assuming that there won’t be much economic benefit to put onto the other. They recognise the possibility that there could be but think that the evidence available at the moment suggests a worse fiscal outcome overall is more likely than a better one and so they make that their central assumption.

Only time will tell, but let’s go with this for now. These increased costs would have to be paid for somehow, and regular readers might remember that something often highlighted by commentators (and indeed the OBR itself) is how migration might mitigate the impact of an otherwise ageing population on fiscal sustainability. The picture below of the FSR2015 projections ‘shows’ that an otherwise unsustainable fiscal position could be brought back within the bounds of sustainability with migration averaging 225,000 a year over the long-term rather than only 105,000. The ‘central’ line here is the same as the dotted line in the first chart above. Although on these projections constraining net migration to barely 100,000 a year does not prevent the debt/GDP ratio from being brought down to below 60% and held there over the next two decades, from then on things become increasingly ‘usustainable’ unless migration is higher. Arguably, ‘sustainability’ can be sustained for much longer, for a further two decades at least, through maintaining net migration at (historically) very high levels for further decades.

However, the picture looks very different using the projections now being made in FSR2017. It’s below, but note that the Y-axis scale has to be changed significantly! The new projections up the high net migration assumption to a full 265,000 a year, while keeping the low migration assumption at 105,000. The picture shows again that levels of migration make little difference to sustainability on a twenty-year view, but what’s new is that although the lines still diverge thereafter, even net migration of 265,000 a year fails to prevent unsustainability simply soaring away.

What’s the takeaway from this? I think it shows beyond much doubt (as I’ve now argued in relation to three successive Fiscal Sustainability Reports) that despite the prominence given to migration in the narrative of the reports (and the media and commentators reporting of them), migration is really a bit of side-show, and far from a fiscal panacea.

The UK’s poor fiscal position was not caused by a lack of migration, and nor can its painfully slow deficit reduction, let alone progress towards debt reduction, be attributed to not enough migration, bearing in mind that net migration has continued for some time now at record levels. Thus I think a lot of the time and effort expended on ‘proving’ potential fiscal benefits of future migration might be better spent exploring different things. If the OBR are anywhere near correct in their latest projections, then arguing about the ‘right’ level of migration from a fiscal point of view might with hindsight be seen to have been little more than fiddling while Rome burned ….