Download 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
Impacts of a one year increase in working
lives on income tax as a proportion of
total income with different spending
and borrowing assumptions
1
3
20
4
9
Fixed spending and deficit
20
4
7
20
3
3
1
9
7
5
20
3
20
3
20
3
20
3
20
2
5
Increased governments spending
Fixed spending and deficit reduced
20
2
1
9
7
5
3
1
3
20
2
20
2
20
2
20
1
20
1
20
1
20
1
20
1
9
-0.014
20
0
– 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