Break free of the fiscal rules

In pre-coronavirus days, immediately following the Tories’ huge election victory in December, this Budget was trailed as the thing that would tell us what the ‘levelling up’ mantra really meant. Things haven’t quite worked out that way. First a Downing Street squabble led to Boris Johnson replacing Sajid Javid as the chancellor, giving the newly appointed Rishi Sunak only a few weeks to prepare for the set-piece occasion.

Then, more significantly, informed commentators such as the Institute for Fiscal Studies (IFS) drew attention to the government’s self-imposed financial straitjacket. With the economy only slowly chugging along, a significant boost to public spending was boxed in by the Conservatives’ manifesto pledge not to increase income tax, VAT or national insurance alongside the simultaneous announcement of a revised set of restrictive fiscal rules. The new rules promised to balance the current budget within three years, only allowing borrowing for capital spending, itself bounded by an investment ceiling of three per cent of GDP.

Then, as the government contended with this spending-taxing-borrowing trilemma, coronavirus struck. Appropriately the Budget was redrafted to focus on measures to combat the impact of the outbreak and the steps taken to contain it. Commendably, Sunak began his Budget statement by announcing extra healthcare resourcing and special support to help people and businesses to weather the cashflow impact of the responses to Covid-19.

He sent the reassuring message that the government would do ‘whatever it takes’ financially to fund the country through this health crisis. The government must now follow this up to ensure the cash gets swiftly to the individuals and firms that need it. Given the gruelling experiences many people still have with obtaining universal credit, reliance on the normal benefits system to get money to people would clearly be naive of the Cabinet.

Adding meat to ‘levelling up’?

Maybe because of the necessary focus on the coronavirus impact, we learnt little new about what ‘levelling up’ means. Or possibly that was because the government is also still not quite sure what the phrase stands for. Sunak was clearly getting a little carried away by his rhetoric when he claimed that this Budget had already delivered – got done – the election promise to ‘level up’.

Yes, the chancellor said that the Treasury would in future include regional equity within the criteria for deciding on public investment projects. The resulting additional spending on improving transport, housing and communications outside (and inside) London is hugely welcome by discouraged and frustrated travellers – which covers pretty much everyone in the country. But improved infrastructure is not a magic bullet for invigorating the vital private investment in new businesses and sectors needed to provide better jobs and higher productivity.

Even any positive demonstrative effects from new construction are unlikely to happen any time soon. Given how long it takes actually to implement building decisions in Britain – think high-speed rail, airport runways, new roads and housing – people and businesses will probably have a long time to wait before they can take advantage of those faster, more comfortable train and road journeys, those cheaper, high-quality homes, and those quicker, reliable communications connections. Indeed, construction workers and firms located outside the south east should not hold their breath until they secure much of this new money. Undoubtedly, the £500million a year for filling the country’s 50million potholes – who counted them? – should be easier to spend. But how much this will contribute to Johnson’s pledge to turbo-charge Britain is a moot point, especially with the constant spread of 20mph speed limits.

Certainly increased investment in transport, housing and other public works is much needed to begin to reverse decades of shortages and infrastructure decay. However, the measures announced were not quite as dramatic as the political messaging. Somehow, Sunak’s Budget teasers of £600 billion of public investment and three times more per year in net investment than the average over the past 40 years turned into what the government’s Office for Budget Responsibility (OBR) reported as only an additional £23 billion a year on average, or about one per cent of GDP, to reach three per cent of GDP (Table 3.13, p. 90). Sunak announced all this with great flair but the hyped response reveals just how little investment we’ve become used to. Between the Second World War and the late 1970s, net public investment regularly exceeded four per cent of GDP (OBR, p162).

Even by 2024, the OBR estimates that today’s government investment plans will only move Britain up from its consistent bottom-quarter ranking within the 30 OECD advanced countries over the past decade to be still just below the present OECD median level (OBR, p100). Similarly, doubling public spending on research and development (R&D) to over £20 billion a year by 2024 is also a hugely welcome first step, although it only takes Britain back to the levels before the late 1980s. Britain’s economic decay set in before then for bigger reasons than inadequate government R&D spending.

And surely ‘levelling up’ implied rather more than added public spending outside London. Wasn’t it meant to signal something about raising people’s earnings, productivity and greater prosperity for all? With the economy flatlining in the quarter to the end of January (so much for the famed Boris Bounce), and that’s before the coronavirus outbreak has had any economic impact, the national and regional economic challenge is enormous. It goes far beyond spending on public services, infrastructure and research, however wisely that is done. For a start, it requires openly discussing and pursuing a series of disruptive measures needed to break through this sclerotic zombie economy.

The remaining limits to fiscal policy

Sluggish or negligible economic growth – with or without an escalation of the coronavirus impact – puts the distinctiveness of this Budget’s message into context. Sunak broke from the approach of his two Budget-giving predecessors, Philip Hammond and George Osborne, who had always emphasised balancing the books and containing the national debt. In embracing fiscal activism and further government borrowing, the new Conservative government has now accepted the cautious advice coming for several years from many technocrats and economists.

Central bankers in the US, Britain, Japan and the EU have been calling repeatedly for their governments to take greater responsibility for economic management, aware that their easy monetary policies are near exhaustion and have been contributing to financial and economic fragilities. Economists, even from the old mainstream right, have also been pointing to the opportunities for governments to spend more in well-targeted areas, given that borrowing costs are negligible because of those sustained ultra-low interest rates.

The Budget marked the Johnson government adopting such bigger spending horizons, not as early as the US and Japanese governments have, but before the EU. However, all this revived acceptance of budget activism does not expunge the historic failures of fiscal stimulus to fix economic crises and end depressions. Sunak was not born then, and Johnson was not yet a teenager, but they are no doubt aware that it was in 1976 that Labour Party leader James Callaghan declared what became the conventional wisdom. It was not possible for governments to spend their economies out of recession.

Putting Johnson and Sunak, so far at least, as well as most of his Labour Party successors, including Jeremy Corbyn, to shame, Callaghan had the courage to tell his party conference and the country: ‘For too long this country – all of us, yes, this Conference too – has been ready to settle for borrowing money abroad to maintain our standards of life, instead of grappling with the fundamental problems of British industry.’ Unfortunately, those fundamental problems still remain to be grappled with. Borrowing, taxing and spending by governments couldn’t fix the economy then, and they can’t fix it now.

Scrap the fiscal rules

Genuine economic transformation relies upon changing politics, on political transformation. The government this week flunked one budgetary issue that could have pointed in the desired political direction. No doubt drawing on his hedge-fund experience, Sunak hedged a decision on what to do about the fiscal rules, after much speculation that he would address them in the Budget.

Bound by the Conservative manifesto not to borrow to fund day-to-day spending, and the three per cent of GDP cap on public investment, he was right to announce a consultation on these rules. But he was wrong to limit this to him meeting up with a ‘range of experts’. This should be a public discussion. Not just because it is about changing a manifesto commitment, but also because it would be a step towards changing the content of British politics, and a much more refreshing one than announcing big spending plans.

For over two decades, governments of all stripes have been using them to justify their public spending measures. Instead of motivating why public money should be spent on this or that, and why taxes or borrowing are required to pay for it, governments have instead appealed to following the rules. Traditional tax-and-spend debates might not have been the most exhilarating of affairs, but at least they were arguments in the open. When the New Labour government introduced fiscal rules for the first time in 1997, it took even these discussions further away from the public realm.

The main justification for the fiscal rules framework is that politicians can’t be trusted due to human behavioural traits. The IFS summarises the thinking that because governments tend to avoid making tough decisions they suffer from a behavioural ‘deficit bias’ to spend too much and tax too little. Recent governments have thus set their own rules ‘as a self-commitment device constraining future behaviour’.

But the best way for politicians to restore public trust is to motivate why they are doing things in the name of answerability to the electorate. Rule-following expresses the opposite. It is a way of evading accountability by deferring to the rules rather than openly reasoning through the substantial whys and wherefores of proposals and decisions.

A decision to abandon fiscal rules should itself involve public motivation and debate. Breaking free from the existing rules-based fiscal framework would be recognition that there is more to public spending than balancing the books and showing ‘fiscal responsibility’. Although government spending can’t resolve the barriers to firms investing a lot more in new sectors and new jobs, it could help invigorate and accelerate the economy once the conditions for transformative business investments are established again.

To be clear, scrapping fiscal rules doesn’t denote spending with abandon. Callaghan was right. Continuing to spend beyond one’s means simply puts off addressing, and often exacerbates, underlying economic problems. But of great political significance is the fact that throwing out the rules framework would enable public spending to be more accountable to the public.

For instance, borrowing can be a valuable mechanism when it facilitates spending for the future that can’t be afforded out of existing income. This applies to individuals, companies and states. It enables big outlays that will pay off over many years – for individuals maybe buying a property; for businesses upgrading their plant and equipment with the latest technologies; for governments building an airport, seaport, roads or railways.

In contrast, borrowing to maintain current operations, or for consumption, can be an evasive way of avoiding dealing with why we are not creating enough wealth to pay for these. For governments, whether borrowing for particular purposes is justifiable or not should be answerable to the public through full debate of the pros and cons. The same applies to particular levels of taxation and specific priorities for expenditure. The electorate can then hold their politicians to account for their decisions, agreeing or disagreeing with the arguments made.

Judgement reserved

Less than three months since their General Election victory it was somewhat premature, and presumptuous, for the chancellor to declare this Budget ‘gets it done’. A prudent appraisal of this government’s performance should follow after the results, not its pronouncements.

This Budget as a standalone event should also be evaluated on what it delivers. It should be judged by the success of the government’s efforts to get cash and resources to the people and organisations hit by the coronavirus emergency. It should be judged by the speed and scale with which new roads, railways, broadband and homes are built. And it should be judged on whether it has the political courage to leave behind the rules-based, administrative approach to governance and instead restore democratic accountability for its, hopefully, depression-busting economic policies.

Phil Mullan’s new book, Beyond Confrontation: Globalists, Nationalists and Their Discontents, will be published by Emerald Publishing later this year.

Picture by: Getty.