Economic thinktank warns chancellor he may need to accept slower pace of deficit reduction
The west's leading economic thinktank warned George Osborne he might need to accept a slower pace of deficit reduction as it toned down the staunch backing it has provided for the government's austerity programme since the 2010 election.
Admitting it had over-estimated the strength of Britain's recovery from its longest and deepest post-war recession, the Organisation for Economic Co-operation and Development said a "flexible approach" to budget cuts would be called for if fears of a triple-dip recession materialised.
Nonetheless, the Paris-based thinktank again gave Osborne its support as it released its annual healthcheck on the UK economy at a press conference at the Treasury.
But it cautioned that measures would be needed to boost Britain's long-term growth potential and to tackle inequality once recovery was assured. And it joined the Washington-based International Monetary Fund in advising the chancellor that he needed a fall-back position should growth again disappoint in 2013.
"The fiscal stance [the strategy to cut Britain's record peacetime budget deficit] remains appropriate", the OECD said. "However, if growth significantly underperforms expectations over the coming months, the flexibility of the fiscal framework should be utilised." The UK is one quarter of negative growth away from entering a triple-dip recession after official figures for the last three months of 2012 showed that the economy shrank by 0.3%.
The OECD added that the Bank of England should take the lead in stimulating the economy, but that Osborne had won himself enough credibility to slow up the pace of deficit reduction if that was warranted by slower-than-expected growth.
Angel Gurría, the OECD's secretary general, also said the government needed to do more to protect the poor from the impact of budget cuts and to encourage people back into work.
"Fiscal consolidation needs to be embedded in a comprehensive package that also promotes growth. Further structural reforms are key to a stronger, more inclusive and prosperous Britain", he said.
The OECD said a prolonged period of weak growth risked worsening social inequalities. "Labour market conditions are widening the income gap between full-time employees and an increasing share of the workforce on part-time, insecure and often low-paid jobs. This comes in a context where income inequality in the UK was already high and rising before the recession," the report said.
It added: "Fairness is important to ensure public support for the necessary fiscal consolidation effort, which will need to be sustained over a protracted period. Restraint on spending on public services, imposed by the budget situation, will hit the poor hardest, as their consumption of public services is higher relative to their income than for the more affluent and they have less access to alternative services."
The OECD called for efforts to be made to boost skills, to improve work incentives for lone parents and second earners under the Universal Credit welfare reform, improve the Work Capability Assessment and support for return to work for those who are fit, and take steps to tackle fuel and water poverty through better targeted financial support. It said: "Measures to lower childcare costs and increase public support to make work pay for these individuals should be considered, although this comes with a fiscal cost. Other growth-enhancing reforms should also be pursued. Investment in productive assets is low in an international context, hampering innovation and growth. R&D support policies and corporate taxation should be reformed, with more focus on rewarding social returns in excess of private returns. Increased investment in productive infrastructure could boost long-term growth, and would justify further prioritisation in spending."
The OECD said the global economic slowdown and uncertainty about the euro area outlook, coupled with austerity measures and attempts by companies and individuals to pay down their debts were "generating strong headwinds for the UK economy".
It added: "The timing of the recovery is, however, difficult to predict. Official and private growth projections have proved too optimistic over the past two years.
"Risks facing the economic outlook are primarily on the downside, and are particularly linked to international developments, including the euro area sovereign debt crisis, policy uncertainty in the US and the outlook for emerging economies."
The OECD said Osborne was right not to raise taxes or cut spending further in the 2012 autumn statement in an attempt to meet his original 2015 target of reducing public debt as a share of national output. "Nevertheless, global developments have shown that the consequences of losing market confidence can be sudden and severe and a sharp rise in interest rates would be particularly damaging to an economy with the UK's level of indebtedness."