The fiscal budget is more than a matter of balance
As we approach the budget, there has been a lot of discussion about what the right path for fiscal policy is. One question is whether the Chancellor will throw off the shackles of trying to achieve budget balance over the coming years. I addressed this focus on budget balance in an article I wrote for the August NIESR Review, “Sound Finances”: Strategy or soundbite? , and it is worth exploring some of the pertinent issues that come out of that.
The first point to remember is that, ultimately, fiscal policy is a political choice and an important one. The recent obsession with achieving "balance" is somewhat too simplistic and, I think, unhelpfully diverts the discussion from the important choices on tax and spending that should take place in order to allow the electorate to decide between competing proposals.
In fact, before getting into government, the original Conservative austerity drive was clearly communicated as a choice. As George Osborne told the Conservative Party Conference in the Spring of 2009: “We Conservatives don’t need convincing that higher tax rates discourage enterprise and damage economic activity. Like you, I believe in the virtues of lower taxation.” This offered an alternative choice to the incumbent Labour government.
By 2017, however, both parties sound similar on fiscal policy. The Conservative Party’s 2017 election manifesto emphasised “Sound public finances, built on fiscal credibility and a balanced budget by the middle of the next decade.” while the Labour Party 2017 Election manifesto wrote “Our public services must rest on the foundation of sound finances. Labour will therefore set the target of eliminating the government’s deficit on day-to-day spending within five years.”
That both assert their desire to achieve this idea of balance reflects the powerful impact of the austerity drive. In particular, the analogy of the government having a deficit being the same as a household spending on a credit card has likely played a key role in this focus on balance in the fiscal dialogue. But that analogy is flawed. Deficits can be sustained if macroeconomic conditions are favourable.
But because those conditions are themselves dependent on fiscal plans, things get a little complicated. If markets determine that debt now seems unsustainable, then previously-sustainable deficits may no longer be sustainable; instead, surpluses may be required to limit the growth of debt as a percent of GDP. And it is even more complicated because decisions on fiscal policy can impact growth which can affect macroeconomic conditions and hence the deficits that can be sustained.
One argument presented in the immediate aftermath of the financial crisis was that austerity was needed to ensure the UK maintained a favourable credit rating and could continue to borrow at reasonable rates. While, for reasons discussed in the article, it seems unlikely to me that markets would have turned their back on the UK in 2009-2012, bond market conditions have certainly improved since then. Whatever your starting point on sustainable fiscal policy, a longer sequence of deficits is now more sustainable than at that time.
Moreover, markets need to be given credit to be able to work out the implications of any fiscal plans. If the government, on November 22, said it was planning to borrow more in order to invest in the UK’s transport infrastructure, for example, then I do not believe that markets would react badly. They may react positively and, once completed, the infrastructure could contribute to an efficiency boost to UK firms through easier transport and logistics for goods, and better access to appropriately-skilled workers.
The key message is not to be unsustainable, but rather to consider more carefully what sustainability means.
It does not mean turning a blind eye to the serious and mounting longer-term budgetary pressures. These issues should be important considerations for political parties in determining their targets for their fiscal plans in the short, medium and longer term. Knowing that such longer-term challenges will need to be addressed, doing so more gradually would ease the impact of the adjustment on any single generation of voters. Decisions to defer when to deal with these issues are equivalent in ultimate impact, even if not in immediate financing need and debt statistics, to deficits; they defer the burden of paying for today’s spending to future generations.
All eyes now turn to the Budget to be announced on November 22nd. Let’s hope it is a carefully considered fiscal plan across all types of spending and taxation, rather than blindly pursuing balance as the goal of fiscal policy.
Michael McMahon is Professor of Economics at Oxford university and is writing here in a personal capacity.