Transcript Prospects for the UK economy

How to pay for the crisis
Ray Barrell
October 2009
NIESR
National Institute
of Economic and
Social Research
The Budget Problem
• Government borrowing is likely to be more
than 10 percent of GDP for several years
• The Debt Stock may rise to 100% of GDP
• The structural deficit is 5-6% of GDP
• There is a permanent output scar of 3-5%
incomes from the financial crisis
– We have less to consume
– Our children will be poorer
• Retiring later allows us to consume more
now and burdens our children les
Conclusions on working lives
• What happens with extended working lives
– Incomes will be higher
– Consumption will be higher
• Governments face options
– Taxes could be cut
– Debt could be reduced
• One year on effective working lives could reduce
government borrowing by 1% of GDP
• Pension systems need to be designed to permit
this to happen
• The pension problem is in part caused by
increases in life expectancy
Raising the retirement age a year
• We assume that the retirement age is raised by
one effective year over 5 years.
– Those near retirement work 66% of normal hours so
its 1.5 years on the age of retirement
– This is anticipated and consumption reacts
immediately to higher expected lifetime incomes
• Factor inputs depend on assumptions
– Labour input rises over five years, and initially
unemployment is marginally higher
– Private sector capital adjusts fully
• Savings fall slowly, the current account stabilises
at a lower level
Extending working lives in the UK
3
National Institute NiGEM model results
2
1.5
1
0.5
0
20
09
20
11
20
13
20
15
20
17
20
19
20
21
20
23
20
25
20
27
20
29
20
31
20
33
20
35
20
37
20
39
20
41
20
43
percent diff from base
2.5
-0.5
GDP
Labour input
Total capital
Government capital
How do we use the money
0.000
-0.004
-0.006
-0.008
-0.010
National Institute NiGEM model results
-0.012
Increased governments spending
Fixed spending and deficit reduced
Impacts of a one year increase in working
lives on income tax as a proportion of
total income with different spending
and borrowing assumptions
43
20
41
39
Fixed spending and deficit
20
20
37
20
35
33
20
20
31
20
29
27
20
20
25
20
23
21
20
20
19
20
17
20
15
20
13
20
11
20
09
-0.014
20
– With deficit
targets direct
tax rates fall
– Direct tax
rates fall more
if government
consumption
and
investment are
unchanged
-0.002
tax rate, diff from base
• Transfers
reduced, direct
and indirect tax
up
How to pay for the banking crisis
• We focus on impacts of a one effective
year increase in working lives starting in
five years, implemented slowly
– saving fall permanently as they are less
needed
– government spending and income taxes are
kept on current plans
• Gains in net revenue mean budget deficit
is better by 1% of GDP after 12 years.
• After 30 years the debt stock is reduced by
20% of GDP
What happens on the way?
• Markets work slowly even when forward
looking but policy can speed them up
• Unemployment will rise by up to third of
the increase in the labour force
– The increase will all be absorbed in five years
– Policy and information can speed adjustment
• Special employment measures for new entrants
• Education campaigns for employers
• Capital accumulates slowly - gains
complete only in equilibrium steady state
• Incentives so capital is put in place more quickly
What are the net revenue gains?
• In 2008 terms a one percent of GDP
budget improvement is almost £15 billion
– 45 per cent from higher income taxes
– 30 per cent from higher indirect taxes
– 25 per cent from lower pensions and transfers
• Policies have to be in place to shift MIG,
TWIRLY, heating and other pension
related payments
• Changes in allowances for wealthy
pensioners may be wise
Modelling savings decisions
• We use the UK model in NiGEM to
analyse policies
• Nigem is a large structural model used for
policy analysis and forecasting
– It can be operated as (equivalent to) a DSGE
with fully forward looking behaviour by
maximising individuals
– We look at the assumptions needed to
analyse the effects of increasing expectations
of life and of increasing retirement ages
Recent proposals
• The Conservative Party proposed raising
men’s (60%) retirement ages by 1 year in
2016 and women (40%) in 2020.
– legislation and social security need to change
– there is bunching or retirement at state ages
• Long run this gives 2/3rds of a percent of
GDP improvement in deficits – say 2023
• Up to 1/3 of a percent of GDP (5 billion or
more) turns up in 2016 – half on benefits
• By 2020 it is 0.5 to 0.6 % of GDP or more
What should be done?
• Move to 3 effective years by 2015 (retire at
70) gives quicker gains
– Growth ½ higher a year for 10 years
– Government borrowing 2% of GDP lower by
2015 and 3 % permanently
– Debt stock lower by 25% in 2025
• Initial surge in unemployment would have
to be dealt with
• We would all consume more