The Office for Budget Responsibility (OBR) is preparing to significantly revise its estimates of Britain's long-term productivity growth, raising important questions about how the independent fiscal watchdog makes its crucial economic assumptions.
The productivity puzzle and its fiscal consequences
According to analysis, the OBR is set to cut its trend productivity growth assumption, marking another adjustment in its ongoing struggle to accurately forecast Britain's economic potential. This would represent the second major downgrade since 2017, when the organisation reduced its long-term productivity growth assumption by half a percentage point following the Brexit referendum.
The significance of this revision cannot be overstated. Trend growth represents the single most important assumption in the OBR's entire forecasting framework, directly influencing projections for tax revenues, welfare costs, and ultimately the country's deficit and debt ratios.
Recent analysis from the Institute for Fiscal Studies highlights the substantial fiscal implications. Their Green Budget estimated that each 0.1 percentage point reduction in annual trend growth increases borrowing by approximately £7 billion by the end of the current parliament.
The transparency challenge in economic forecasting
Currently, the OBR assumes medium-term productivity growth of 1.25 per cent, which when combined with labour supply growth, implies overall GDP growth of roughly 1.8 per cent. This position sits at the more optimistic end of economic forecasts, higher than many other respected institutions.
The fundamental problem lies in the methodology. Like other forecasting bodies, the OBR estimates potential output through a production function approach, breaking down growth into labour, capital and total factor productivity components. However, as OBR committee member Professor David Miles CBE candidly admitted, much of this process remains essentially "a finger-in-the-air exercise."
While expert judgement will always play a role in economic forecasting - particularly when assessing unprecedented events like pandemic recovery or AI adoption - the current discretionary approach leaves the OBR vulnerable to accusations of political bias, especially when revisions occur during sensitive fiscal periods.
Proposed solutions for greater objectivity
To strengthen the OBR's independence and credibility, two primary rule-based approaches have been suggested that could reduce reliance on discretionary judgement.
The first proposal involves adopting a backward-looking, data-driven rule for estimating trend productivity. This would take the form of a moving average over the past five to seven years, adjusted for economic cycles and capital utilisation. The key advantage would be automatic updates as new data emerges, preventing large discretionary shifts that can appear politically motivated.
The second approach suggests anchoring the OBR's structural assumptions to the median of external forecasts from established institutions including the Bank of England, IMF and OECD. This "wisdom of crowds" method would position the OBR comfortably within the consensus view, using the median rather than mean to avoid outlier influences.
Implementation would be straightforward, potentially leveraging HM Treasury's existing monthly survey of independent forecasters to gather the necessary data.
The OBR was established to build trust in Britain's fiscal projections, and its continued credibility depends not only on the integrity of its staff but equally on the transparency of its methods. As the organisation faces another significant revision to its core assumptions, the case for a more rules-based framework grows stronger by the day.
