Sunday, June 14, 2015
First get your budget surplus, then try to keep it there
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Neither will welcome the comparison but George Osborne since the election reminds me of Gordon Brown in the weeks after Labour’s 1997 victory. Both hit the ground running, with a flurry of announcements and initiatives while their cabinet colleagues were getting used to being in office or, in the case of the Tories, back but with an overall majority.

For Osborne, it is like a weight has been lifted. Though I am sure he enjoyed the company of Danny Alexander, his former Liberal Democrat Treasury chief secretary, and all those “quad” meetings with Nick Clegg and Alexander as well as David Cameron, the sense of liberation is palpable. The sometimes Eeyore-ish presence of Vince Cable at the business department might have meant slower progress on selling the rest of Royal Mail and embarking on the disposal of RBS. No more.

The chancellor’s biggest offering, however, is what he described in his Mansion House speech as his “new settlement” for the public finances, “a permanent change in our political debate and our approach to fiscal responsibility”.

That new settlement, to legislate for future governments to run a budget surplus “in normal times”, “to bear down on debt and prepare for an uncertain future”, has been widely greeted as a political trick, intended to kick Labour when it is down, by forcing the main opposition party to commit to a fiscal rule it is probably not comfortable with.

There is some truth in that, as there is in the fact that fiscal rules, even those enshrined in law, are made to be broken, and that no government can bind the hands of its successors. On the latter, however, the chancellor may be aiming for the kind of consensus there is now on Bank of England independence. Just as it is hard to see any new government reversing that, it could be a very big deal if future politicians decided to abolish the proposed fiscal law.

Let me leave the politics aside and take the proposed surplus rule at face value. While some see it as a return to the Victorian era, there is much later experience, if not with permanent surpluses, then at least with far tighter public finances than the recent norm.

Reliable figures for the public finances go back to 1948 and, while it is true that there have only been 12 years in that period when the government has run a budget surplus, the deficit over the period 1948-72 averaged just 0.6% of gross domestic product. This, remember, was the period of fiscal activism, Keynesian demand management.

The current budget – excluding public sector investment – was in surplus in every year from 1948 to 1974, that surplus averaging 3.8% a year. The figures, incidentally, give the lie to the suggestion that tight public finances mean governments cannot undertake necessary investment in the economy.

In the three decades from 1948, when the average overall budget deficit was a tiny 0.6% of GDP, public sector net investment averaged 4.6% of GDP annually. That is roughly three times its average over the past 20 years, not least because much of that investment used to be by nationalised industries.

We are a long way from the golden age of the 1950s and 1960s. The budget deficit has averaged 3.6% of GDP since the early 1970s and, pending revisions, was 4.8% of GDP in 2014-15.

Budget deficits are the norm. Even Canada and Sweden, praised by the chancellor for their successful reforms of their public finances in the 1990s are running deficits, though admittedly lower ones than Britain. For those who believe in legislating for these things, Germany is the current poster boy.

In 2009 it initiated its Schuldenbremse or debt brake legislation, embodied in Article 109 of the country’s basic law, which required the federal government to run a structural budget deficit of no more than 0.35% of GDP. So far it is working.

Aiming for a small budget surplus in normal times –as long as that is not at the expense of an adequate level of public sector investment – is perfectly laudable. It produces a gradual fall in public sector debt and a much more rapid drop in debt as a percentage of GDP. The lesson of recent years, discussed last week, is that if you go into a crisis with a significant deficit the subsequent pain is much greater.

There would be battles between the politicians and the fiscal watchdog, the Office for Budget Responsibility, charged with determining what the public finances should be in a given year. For the Treasury this would be ultimately be a good thing; the OBR would be an ally in reining in the spending ministries.

The first big task, however, is to get to a surplus, the equally challenging second to is keep it there. Neither will be easy. Though official projections are for a small budget surplus of 0.2% of GDP in just three years’ time, there is a serious risk that this represents the triumph of hope over experience.

Now he has been liberated from coalition, Osborne has a chance to do what should have been done in 2010; a Canadian-style root and branch review of the role and limits of government, together with a mechanism for ensuring that the lower level of spending is permanent, not just the temporary low point achieved after a long squeeze. Though Canada is now running a small deficit, its public finances are far healthier than Britain’s.

There is a chance to do this in this autumn’s spending review, with the new Treasury chief secretary Greg Hands charged with achieving it. It may be the only chance. Public spending is the equivalent of roughly 40% of GDP, having peaked at nearly 46% of GDP in 2009-10. Tax receipts appear to be stuck at just over 36% of GDP. So spending needs to be brought down to 36% of GDP or less.

That will not be easy, and neither will be keeping it there. The OBR’s latest fiscal sustainability report, which looks at the public finances over the long-term, has some striking findings. Scottish Nationalists hoping to build an economic future on North Sea oil will have discovered that the cupboard is bare. The OBR expects only £2bn of North Sea revenues in the 20 years from 2020 – in total – down £37bn from the OBR’s assessment a year ago.

The ageing population, the biggest source of extra spending, will add 1% of GDP to public spending each decade on current policies. The OBR sees public sector debt falling as a percentage of GDP on current policies until the 2030s, assuming accidents can be avoided, after which it starts to rise strongly again.

In the long run, as Keynes said, we are all dead. But in the long run too there will be significant upward pressures on spending at a time when the outlook for some of the taxes to pay for it is at best uncertain, at worst dire.

It makes sense to try to prepare the public finances for such pressures. If, over the next 25 years, the result was a small budget deficit of the kind we saw from the late 1940s to the early 1970s, rather than the surplus Osborne aims to enshrine in law, it would still be a considerable achievement. But, as I say, it requires some hard thinking about the role and scope of the state. The election campaign, rich with promised giveaways on both spending and tax, was not notable for such hard thinking. Let us see what the next few months bring.