Balancing budgets

By Buttonwood

BRITAIN'S parliament passed the "charter for budget responsibility" in a move that was seen as a tactical triumph for George Osborne, the finance minister, largely because it led to a u-turn in opposition Labour policy. The charter is designed to achieve a budget surplus in "normal times", with an immediate aim of the 2019-2020 fiscal year.

The use of the "normal times" phrase is designed to get round the usual objection to balanced budget amendments; that they prevent governments from using fiscal stimulus to revive the economy in a recession. The charter says that

These targets apply unless and until the Office for Budget Responsibility (OBR) assess, as part of their economic and fiscal forecast, that there is a significant negative shock to the UK. A significant negative shock is defined as real GDP growth of less than 1% on a rolling 4-quarter-on-4-quarter basis. If the OBR assess that a significant negative shock: occurred in the most recent 4 quarter period; is occurring at the time the assessment is being made; or will occur during the forecast period then: if the normal times surplus rule in 3.2 is in force, the target for a surplus each year is suspended (regardless of future data revisions).

Still, Ha-Joon Chang argued in the Guardian that the rules are still unnecessarily restrictive. If interest rates are low, then a government (just like a business) has the scope to make investments that offer a return greater than the cost of borrowing.

a government can increase its means in the long run by borrowing to invest in things that will make the economy more productive, and thus increase the tax revenue. If a government invests in improving the transport system, it will make the country’s logistics industry more efficient. Or if it invests in healthcare and education, that will make the workers more productive.

The danger of Mr Chang's argument is that governments may overestimate the return from its investment, and may spend money unwisely. But a better argument against the charter came from George Osborne himself. When Gordon Brown tried to bring in a "fiscal responsibility bill" in 2010, Mr Osborne quipped in the House of Commons that

Let us remember what one of the economists whom the Prime Minister himself appointed to the Monetary Policy Committee has said about the Bill. Willem Buiter has said:

"Fiscal responsibility acts are instruments of the fiscally irresponsible to con the public."

No government can bind its successors in this way. If a Labour government has a majority, it can drop Mr Osborne's charter. And if Mr Osborne is still in power after the next election, he can pursue whatever fiscal policy he wants; he doesn't need the charter. So the whole thing is irrelevant. Gordon Brown had a "golden rule" that the budget should balance over the course of the cycle, but had plenty of scope to define the cycle, so the policy became a bit of a laughing stock by the end.

As an "anti-austerity" party in favour of higher public spending, it is hardly surprising that Labour opposed Mr Osborne's charter in the end; the surprise was that it was willing to support it two weeks ago. But its policy still seems very confused, as Mr Chang points out. In his letter to MPs, John McDonnell warned about a deteriorating global economy, writing that

The tone of our debate now also has to shift to a much more serious analysis of what our economy is likely to face in the coming year.

In the last fortnight there have been a series of reports highlighting the economic challenges facing the global economy as a result of the slowdown in emerging markets. These have included warnings from the International Monetary Fund’s latest financial stability report, the Bank of England chief economist, Andy Haldane, and the former Director of President Obama’s National Economic Council, Lawrence Summers.

So if the economy is about to turn down, Keynesians would argue that further fiscal stimulus is needed or, at the very least, no tightening. But Mr McDonnell goes on to say that

We will set out our plan for tackling the deficit not through punishing the most vulnerable and damaging our public services but by ending the unfair tax cuts to the wealthy, tackling tax evasion and investing for growth.

There are several positions that Labour could logically take.

1. The economy is weakening so the automatic fiscal stabilisers should be allowed to apply.

2. The economy is weak and we need a fiscal stimulus; this will be achieved by increasing spending and raising taxes on the wealthy/corporate sector, with a net stimulus being delivered because spending will increase more than taxes (these first two options rule out "tackling the deficit").

3. The economy is strong enough that the deficit will correct automatically via higher tax receipts and lower benefit spending as employment increases; there is no structural deficit, only a cyclical one.

4. There is still a structural deficit and we need to tackle this by eliminating tax evasion; the economy is strong enough to take this fiscal tightening (these last two options seem to negate the argument that the outlook has suddenly weakened).

Labour doesn't yet seem to have settled on any of these options; it needs to do so if it is to have a coherent policy.