Rachel Reeves in her
conference speech (text version) only mentioned the word ‘iron’
twice (‘iron discipline’ and ‘iron-clad fiscal rules’) but
that and the nature of her speech was enough for the headline writers
to label her as a potential Iron Chancellor. Which, I suspect, is
exactly the way she and her team would have wanted it.
Thanks to the
combination of a Global Financial Crisis (GFC) and the right wing
press with its influence on the mainstream media [1] the last Labour
government ended with a reputation for being loose with the nation’s
finances. That reputation is completely undeserved, as I have shown
many times, but it is impressions that matter here. In contrast,
because of austerity, the Conservatives get far too easy a ride. It
is the Conservatives who have treated fiscal rules as something you
change every other budget to suit the numbers or politics, yet it is
Labour who have to say their fiscal rules will be iron-clad.
The reality is that
the fiscal rules Reeves is proposing are almost exactly the same as
adopted by John McDonnell when he was shadow Chancellor. Let me
repeat that. The reality is that the fiscal rules Reeves is proposing
are almost exactly the same as adopted by John McDonnell when he was
shadow Chancellor. The big difference between the two shadow
Chancellors is that McDonnell announced higher spending and taxes
that satisfied those rules (in 2017 at least), but Reeves has been
more cautious, so far. In addition, Reeves with Starmer’s support
has exerted more discipline on other shadow ministers over what they
commit to.
At the centre of
these fiscal rules is the golden rule: aiming to match current
spending with taxes. However no Chancellor would be foolish enough to
try and do that year to year. Best practice for a government like the
UK is to have a rolling five year ahead target. I talked about why
the golden rule is a good fiscal rule recently here.
That rule is fine as
long as the economy is doing OK. The catastrophic mistake George
Osborne made was to try and follow it when the economy was just
starting its recovery from the GFC recession. [2] Since then, fiscal
rules have often had clauses of various kinds to deal with that
situation. Labour’s proposed rules do that too, by saying that in a
crisis or the recovery from it fiscal policy would be used to support
the economy rather than meeting the golden rule. Whereas McDonnell
suggested that the Bank define when that was necessary, Reeves has
the OBR doing that job. So Labour’s fiscal rules will not repeat
the disaster of 2010 austerity.
Crisis apart, the
golden rule implies using borrowing to invest, and again Reeves has
been very clear that this is what Labour will do. However, like
McDonnell’s fiscal credibility rule, Reeves also has the commitment
to reduce government debt as a share of GDP, probably as a rolling
five years ahead objective. This was included by McDonnell’s team
in their fiscal credibility rule against my advice, because it was
thought to be politically necessary to do so.
As regular readers
will know, my negative view on targeting debt to GDP (or any stock
measure for that matter) has not changed since I
wrote this with Jonathan Portes. That successive
Shadow Chancellors feel the need to include a poor target because
otherwise they would get a lot of flak from the media tells you all
you need to know about the lack of economic expertise in our media. That
expertise says that government debt is not a bad thing, sometimes it
is good to let it increase, and we have no reason to believe that
current levels of debt are in any way harmful or risky. To suggest
that a government that follows the golden rule would be irresponsible
if it failed to reduce its share of debt in GDP is just economic
illiteracy.
Hopefully this
particular target will disappear once Labour are elected. It probably
needs to because the amount of additional public investment
that is needed after years of underinvestment is immense, and it
would be a crying shame if this didn’t happen because of a daft
fiscal rule. Because public investment encourages growth it helps
reduce debt to GDP in the longer term, so cutting back on such
investment because it would in the short term raise debt to GDP is
classic short-termism.
Turning back to
current spending, it is clear that the next government, whatever its
colour, will have to raise taxes and spending once they are in power.
As Sam
Freedman says here “Starmer’s holding position
that he wishes to run “a reforming state, not a cheque-book state”
is transparent nonsense”. As I suggested
here, the only issue is whether a Labour government
does the politically smart thing and acts boldly to increase a
variety of taxes in its first budget, or whether tax increases are
reluctantly spread out over its first term. The public’s desire for
more tax and spend is clear from the latest British Social Attitudes
survey, although not quite as strong as it was in the nineties.
Reeves’s line that
money for additional spending will come from growth is also at best a
holding position. Spending on the NHS, social care, education and so
on as a share of GDP needs to rise, which means higher taxes
as a share of GDP. Once again, those who criticise these fictions of
reform or spending through growth really should focus their attention
on a media that makes such fictions a sensible political strategy for
a Labour opposition that wants power.
Will Labour be
constrained by the macroeconomic situation it finds itself in? We can
consider two possibilities, even though reality will probably be
somewhere between the two. The first is that inflationary pressure
and high (by recent standards) interest rates continue. As long as
Labour follow the golden rule, any extra current government spending
should not be too inflationary because they are funded by permanent
increases in taxes. [3] The shift from private sector to public
sector spending will happen through higher taxes.
The same is not true
for additional public investment, however. In this case the shift
from consumption to investment will come through higher than
otherwise interest rates. However the impact on interest rates is
likely to be small, as public investment can increase substantially
in proportionate terms without rising very much as a share of GDP.
Perhaps more of a concern will be getting the resources for the
projects (e.g. construction workers).
The second
possibility at the other extreme is that UK inflationary pressure
disappears very quickly, as the lagged effects of recent rises in
interest rates begin to be felt. At worst, the UK may be in recession
when the general election is finally called, and by the time Labour
takes power interest rates could be back to their lower bound. In
some ways this reduces Labour’s problems, because they can in the
short run use increases in public investment and current spending
to boost the economy. However, one big advantage of rolling five
year ahead targets is that the recession will be forecast to be over
in five years, so the tax implications of permanently higher current
government spending cannot be avoided.
One final point that
Reeves’s speech brought home was that Labour will be fighting the
2024 election not just its traditional ground of public services but
also on the economy. To Reeves’s credit, she has been persistent at
putting better growth at the centre of her message. While I agreed
with that, if only because the Conservative’s record has been so
poor, many others thought otherwise, because of the structural
reasons why the Conservatives tend to perform better in polls about
‘the economy’. Reeves was correct, and not just because of Truss:
Labour were
level with the Conservatives on the economy six months
earlier. What the Truss disaster ensures is that even if growth picks
up next year, the Conservatives are unlikely to get much credit for
it. [4]
[1] Also to some
extent due to the failure of Labour to counteract this message, in
part because they had an extended leadership campaign.
[2] The centrepiece
of Osborne’s fiscal rules was also a 5 year rolling target for the
current deficit. That rule was adopted because it was suggested by
the IFS, who Osborne’s advisor Rupert Harrison had worked for.
Unfortunately the IFS do not do macro, so their thinking ignored the
problem of recessions where interest rates hit their lower bound.
[3] In theory a
permanent increase in taxes should lead to an equal decline in
consumption. There are two reasons why there might nevertheless be a
positive impact on GDP. First, consumers may not regard the tax increases as
permanent. Second, private consumption tends to be more import
intensive than government spending.
[4] Before the 1997
election, the economy had been recovering well for a few years, but
it wasn’t enough to help the Conservatives, in part because the
forced exit from the ERM had blown their reputation for economic
competence.
