Our ‘iron chancellor’ is set for a humiliating climbdown
When the going gets tough, simply change the rules. That’s been the pattern with successive chancellors ever since Gordon Brown first imposed supposedly binding fiscal rules to keep the public finances on the straight and narrow nearly 30 years ago. And now, it seems, they are to be changed again.
They never last long. The rules have been rewritten no fewer than nine times since 1997, seven of them under Tory-led governments. That makes their average life span less than four years, which is the shortest of any OECD country with comparable constraints.
Nor have these changes brought the UK any nearer the intended goal of debt sustainability. Since the days of Tony Blair’s first government, the national debt has risen from a post-war low of around 20pc of GDP to nearly 100pc today.
According to recent analysis by the Office for Budget Responsibility (OBR), on unchanged policies debt is destined to swell even further to a jaw-dropping 274pc of output by the mid-2070s.
This is only a projection, not a forecast, and in practice will never be met; the markets would put their foot down long before we reached such a perilous state of affairs.
But it gives some idea of the scale of the problem: the country is already living way beyond its means, and from defence to health and social care, nevermind crumbling infrastructure and the proposed energy transition, all the pressures on public spending are upwards.
As is now obvious, Labour has dug itself into the most frightful hole on these issues. In order to get itself elected, it pretended it could live within existing fiscal constraints without having to raise any of the main rates of taxation.
Anyone with half a brain could always see that the promise was delusional. Now that this has duly proved to be the case, the Chancellor, Rachel Reeves, has fallen back on another fiction – an almost entirely invented £22bn “black hole” in the public finances which she disingenuously claims not to have known about before getting her hands on the books.
Having promised on the campaign trail to be broadly bound by the fiscal rules established by the last government, Labour’s high command has been dropping heavy hints over the past week that this too is about to be junked, with the rules once more adjusted to accommodate spending plans.
To be fair, nobody would think the fiscal guardrails as currently framed are fit for purpose. On virtually every front they are deeply flawed. The main rule is that policy should be constructed so as to ensure that debt is falling as a proportion of GDP in five years’ time.
Like a constantly receding horizon, the target date is reset at every fiscal event, with the result that the future never arrives, making the rule the very embodiment of the St Augustinian prayer – please make me chaste, but not yet.
By promising to do painful things in the future that in practice never get done, the rules are easily gamed. The letter of the rules can also be met by sleight of hand – one-off policy actions, such as the sale of the student loan book, which do nothing to improve debt sustainability.
When the debt rule is met, the difference is banked and spent, and when it is not, it is simply changed to accommodate whatever it is the Government wants to do.
So no doubt about it, the system does need to be rethought. As widely suggested, reintroducing a form of Gordon Brown’s “golden rule”, under which borrowing for public investment would be treated differently from borrowing for current spending, makes some sense.
Part of Britain’s productivity problem is that it has some of the lowest levels of investment, both public and private, in the OECD. All UK governments promise to do something about this deficiency, but none in recent times has made much progress.
In any case, as pointed out by a group of economists in a letter to the Financial Times this week, the current fiscal framework conspires to support short-term thinking and creates an in-built bias against investment.
In fiscally constrained times, governments typically choose to cut investment rather than welfare. If investment was ring-fenced for borrowing purposes, it might protect capital spending, which would help long-term growth.
This would in turn support debt sustainability, since by facilitating an increase in growth it would increase the denominator in the debt-to-GDP ratio. That’s the idea, in any case.
Whether this is what would happen in practice is another matter. You only need to look at the vast overspends on HS2 and Hinkley Point C – the first of which is being paid for directly by the taxpayer and the second of which is essentially underwritten by the public purse – to see that not all investment is necessarily a good use of money. Much of it is just pork barrel politics, plain and simple.
Besides, rules designed to protect investment through the cycle tend to get ditched anyway whenever backs are against the wall. For instance, Brown’s golden rule did nothing to prevent Labour taking the axe to capital spending budgets in the wake of the financial crisis.
Would the new Government be prepared to run a surplus on current spending in order to pay for enhanced borrowing for investment? You can bet your boots it would not. The decision to cave into a tsunami of public sector pay demands tells you exactly where its priorities lie.
Fiscal rules come and go, but in the end, says Robert Chote, former head of both the Institute for Fiscal Studies and the OBR, actions speak louder than rules when it comes to fiscal credibility; in order to be confident of debt sustainability, what the markets need to know most is that, when push comes to shove, the Government is prepared to do unpopular things.
Abolition of the universal winter fuel allowance should very much be seen in that context. It doesn’t save a lot of money, but in stirring a backbench rebellion which is then faced down, it signals political backbone.
Yet it is also something of a charade. Thus far, there has been no serious attempt by the Government to confront the reality of its disposition. Having ruled out any increase in the main sources of taxation, it has no answers as to how it is going to finance the myriad public spending pressures now building up in the system. From defence to healthcare and dilapidated infrastructure, each of them demand an extra one to two percentage points of GDP in spending.
Further reforming the fiscal rules may have merit, but it’s no panacea.
Ultimately, there is only one parameter that really matters when it comes to debt sustainability – that over time, government spending, whether it be current or investment, always grows less strongly than the economy.
Good luck in pursuit of this nirvana, Chancellor – you’ll need it.