Fiscal rules: a political question

Chris Giles and Anatole Kaletsky have both called for the government to introduce a new set of rules for fiscal policy, now the old ones are torn up. What they don’t fully address is the question: why, exactly, do we need such rules?
We need them because the obvious restraints upon government - markets and voters - aren’t working.
Back in the 60s and 70s, big government borrowing was punished by financial markets. Any hint that the state would borrow too much led to rising gilt yields - and hence higher borrowing costs for companies - and pressure on the pound. For this reason, in the 50s and 60s government’s had to stick to a form of Brown’s golden rule - and in the 70s they learnt the costs of failing to do so.
But in globalized markets, this restraint no longer applies. Yield spreads between 10 year gilts and their US or German counterparts are lower now than at the start of the month, suggesting financial markets couldn’t give a monkey’s about the abandonment of the old fiscal rules.
However, voters should give a monkey‘s. Chris says the new fiscal framework

should foster budgetary sustainability and intergenerational equity, so one generation does not live the life of Riley and leave problems for its children to clear up.

Which raises the question: why do we need external rules to do this? Why can’t the electorate do it? Younger voters should see that big borrowing is merely deferred taxation, and punish governments for imposing it. And older voters who care about their children and grandchildren should also  punish governments.
So why don’t they? One possibility is that our electoral system is just too clumsy to permit them to express their discontent; we are only ever offered a choice of job-lots of policies, not individual ones.
Another possibility is that, for all our drooling and drivelling, we as a nation don’t actually care about our children.
Whichever it is, let’s be clear. If we need fiscal rules, it is only because of moral and/or political failings. But are technocratic constraints really an adequate substitute for adequate political structures or more sophisticated moral sensibilities?

Comments

[Bob B]

The original purpose of the rules, surely, was not for economic reasons but rather to facilitate the political management of the spending aspirations of the Labour Party, ministers and senior civil servants.

In times past, the Labour front bench in Parliament was flush with academic talent in economics with the likes of Hugh Dalton, Gaitskell, Harold Wilson, Douglas Jay, Tony Crosland, Woy Jenkins and more but those times have long since gone. Like families, marriage and physics, economics has also become unfashionable:

"The figures for economics A-level students have been in a prolonged downturn - down by more than a quarter between 1996 and 2006 to about 17,000 - with the subject overtaken by a range of other subjects that have become much more popular.

"There are three times as many pupils taking psychology A-level as economics and almost twice as many taking A-level media studies. Sport and physical exercise and the expressive arts are now bigger subjects at A-level than economics."
http://news.bbc.co.uk/1/hi/education/7525170.stm

From time to time since the mid 1990s - sometimes with gaps of a year or so in between - I drop into Blackwell's on Charing Cross Road in London to browse the economics books. When I started, there was a large economics section prominently sited in the store. The section is now small and when I was last there, a couple of months back, I had to ask where it was.

The politics section is larger and more conspicuous. Curiously, according to this report last summer in The Times, economics graduates are relatively well paid compared with graduates in most other subjects:
http://www.timesonline.co.uk/tol/life_and_style/education/good_university_guide/article2253011.ece

[kinglear]

The only time we care about our children nowadays is when they get stabbed - when they are instantly transformed into boys or girls that everyone likes,never in trouble, heartbroken ,blah blah.
So where are the ones we all know - the toerags? Ah theyve been airbrushed out.

[Richard Hancock]

The Chris Giles link is to the Anatole Kaletsky article, and vice versa.

[chris]

Thanks - links are fixed now.

[Bob B]

Perhaps unsurprisingly, there's little mention lately of how PFI - the Private Finance Initiative (PFI) - was widely used to circumvent Gordon Brown's Golden Rule in financing expedient public sector capital projects:
http://en.wikipedia.org/wiki/Private_Finance_Initiative

Here are some of the drawbacks of PFI as exposed by the HoC Public Accounts Committee:
http://news.bbc.co.uk/1/hi/uk_politics/7113770.stm

[passer by]

I agree, its morally bankrupt to pass your debts onto your children or next generation, but we do not live our lives on such long timetables. On my personal level I have a plan for the here and now and one in the medium term, over the next 5 years, after that who knows, I might not be here to see it anyway.

The solution might be just something simple like sending the differed tax bill out as well as the real one, just to highlight the fact, that this is a real bill with real money.

Or we could move to a system of minimum income and prospective governments would be forced to have a 5 year budget from day one in office approved by the voters.

[ad]

"Why can’t the electorate do it?"

Because most voters haven't a clue whether the Government is borrowing heavily or why?

[tolkein]

What's wrong with (some) borrowing from the future? We're going to leave them lots of assets they didn't have to forgo uncome for, and they are likely to be a great deal richer than the present generation? When I was first taking out a mortgage it was 2x joint income. Current public debt is only 40% of national income.
Just asking.

[Bob B]

"Just asking"

Check out the column: "Budget balance % of GDP 2008" in this table in the current issue of The Economist:
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=11792771

What the table shows is that Britain's current budget deficit as a % of GDP at -3.6% is larger than that of almost every other country shown in the table - Pakistan and Egypt are the only countries in the table with larger budget deficits relative to national GDP.

Respected independent commentators - like the IFS and Item Club - have been posting warnings about the holes in Gordon Brown's budgets for at least the last five years, as this shows:
http://news.bbc.co.uk/2/hi/business/2706495.stm

By today's news, Britain's economy has slowed sharply and the worry is about the possibility of a recession developing. Typically, with unchanged tax rates, tax revenues fall sharply in recessions and public spending rises with unchanged policy commitments as payment of work-seeker allowances (or unemployment benefits) increases. The inevitable consequence is budget deficits will grow when we already have an extraordinarily large budget defict compared with other peer-group affluent countries.

The big question then is whether that could adversely affect the terms on which the government here can borrow in turblulent capital markets to finance its increasing budget deficit.

[Mark Harrison]

Oh Chris,

It is clear that you spend too much of your time with the X% of the population who UNDERSTAND that public sector borrowing is building up debts our children will have to pay.

The majority of people I speak to about such things simply hadn't put two and two together and worked out that this was the case, or at best, assumed that the debts wouldn't ever be repaid but just balloon larger down history.

[Bob B]

Cameron has been under great political pressure to announce a commitment to tax cuts in the event the Conservatives win the next general election but has recently refused to do that and suggested it could be necessary to raise taxes to "ensure strong public finances".
http://news.bbc.co.uk/2/hi/uk_news/politics/7516046.stm

[Alex]

No-one ever talks about the moral horror of passing on a burden of unbuilt railways to our kids.

Rules, by the way, are famously intended for the guidance of wise men and the observance of fools.

[Bob B]

"Rules, by the way, are famously intended for the guidance of wise men and the observance of fools."

Regretably, the financial markets don't always see it that way, which is why we have the subprime mortgage debacle in the US reaching out across European financial markets and why the banks in Britain are now so reluctant to lend to each other as they used to and why we have the credit crunch.

Try this: IFS A Survey of Public Spending in the UK:
http://www.ifs.org.uk/bns/bn43.pdf

Chart 2.1(b) shows public spending as a percentage of GDP with a big hump in the mid 1970s as public spending got out of control with a Labour government in power. That resulted in the financial crisis of 1976 when Denis Healey, as Chancellor, was on his way to a meeting of the IMF in Washington had to turn round at the airport and fly straight back to Britain again to apply for and negotiate the terms of a loan from the IMF so the government would have the wherewithal to prop up the sinking Pound.

By the standards of peer-group countries, Britain now already has a large budget deficit relative to GDP, which will tend to grow as the economy slows further and especially if it goes into a recession. The industrial sector - now only about a quarter of Britain's economy - is already in recession.

Tony Woodley, a trade union general secretary, in a BBC radio interview was recently proclaiming that Britain had the fourth richest economy in the world.

If only that were true. Some years ago, Britain did have the fourth largest economy in the world but we now rank only six or lower having been overtaken by China and France. A Euro now costs 78p but it was c. 75p in January this year when the BBC reported that exchange rate as a record low:
http://news.bbc.co.uk/1/hi/business/7182951.stm

A sinking Pounds means that imports cost more in terms of Pounds.

[Alex]

....which is why you should always use PPP rates for international comparisons.

[Bob B]

"....which is why you should always use PPP rates for international comparisons."

Not necessarily so: it depends on the intention in making the particular international comparison.

If the purpose is comparing living standards of the residents of different countries then PPP exchange rates are appropriate but not if the purpose is to compare international purchasing power of GDP in terms of national currencies at prevailing market exchange rates.

PPP exchange rates are not simple to calculate and are potentially contentious. Just what so-called "typical" shopping basket of goods and services is to be used to make the calculation of the internal purchasing power of a currency - a typical American shopping basket, a European basket or the shooping basket of a consumer in, say, India?

In 1986, to cut through the problems, the weekly The Economist half-jokingly proposed using the price of a standard Big Mac burger in different countries as the basis for making international comparisons between the purchasing power of national currencies from a resident consumer's perspective:
http://www.economist.com/finance/displaystory.cfm?story_id=6972477

At least the Mac burger index brings out some of the potential hazards of using PPP exchange rates.

[tolkein]

According to the CIA Fact book (jolly useful, too) UK GDP for 2007 (at market exchange rates) was US$2.773 trillion. France's GDP was US$2.56 trillion. In PPP UK GDP was US$2.137 trillion and France was US$2.047 trillion. UK GDP is still larger than France.

[Bob B]

Yes but the Pound has depreciated against the Euro since last year:
http://finance.yahoo.com/currency/convert?amt=1&from=GBP&to=EUR&submit=Convert

Scroll down for a graph showing the drop in the number of Euros to the Pound since September of last year.

[Bob B]

What a coincidence!

Since September of last year, the price of a Euro has gone from 68p to just over 78p today, which amounts to a depreciation of the Pound by about 14.7%.

On this day 19 November 1967:

"The Prime Minister, Harold Wilson, has defended his decision to devalue the pound saying it will tackle the 'root cause' of Britain's economic problems.

"The government announced last night it was lowering the exchange rate so the pound is now worth $2.40, down from $2.80, a cut of just over 14%. . . "
http://news.bbc.co.uk/onthisday/hi/dates/stories/november/19/newsid_3208000/3208396.stm

[tolkein]

Bob, the CIA page for the economy was last updated 24 July 08. I'm guessing that the market exchange rate reflects current rates. Even so the PPP is greater than France. But the original point I was trying to make was that we're going to hand on an economy with a lot of infrastructure to our grandchildren who'll be a great deal richer than we are. So what's wrong with some borrowing to pay for us to hand on this infrastructure to them?

[Bob B]

"So what's wrong with some borrowing to pay for us to hand on this infrastructure to them?"

As a criterion for borrowing, that sets no limits at all on the scale of borrowing, which is presumably why Gordon Brown in 1997 introduced his famous Golden Rule(s) for fiscal policy to restrict government borrowing to what he deemed were "prudent" limits.

It's therefore all very curious to be told now that the Golden Rule(s) don't really matter and that it's OK for the government to borrow, apparently without restriction, in order to hand on more infrastructure to future generations even though those future generations will be paying the debt servicing costs for decades to come.

Besides, what if the infrastructure that the government decides is good for future generations turns out to be out moded and worthless?

Famously, past governments invested heavily on behalf of taxpayers in advanced gas-cooled nuclear power stations which turned out to be an especially expensive technology for nuclear power which wasn't emulated elsewhere. Instead, we are now anxious to encourage EDF, the French state-owned energy company, to take over the construction of new nuclear power stations in Britain on the hugely successful French model, which presently accounts for nearly 80% of all electricity generation for French consumers - who aren't complaining about nuclear powerstations.

What of the hundreds of millions of taxpayers' money invested in the Selby Coalfield, which turned out to have fatal geological faults?

Even in America, much of the serial problems linked with subprime mortgages seem to have originated with Fannie Mae and Freddie Mac, which are officially regarded there as government-sponsored enterprises.

On the documented evidence, we really ought to be especially sceptical about reposing much faith in the supposed prescience of government agencies when these invest in infrastructure for the sake of future generations. All too often, decisions are made because of political pressures and without much regard to market merits - and believe me, I'm familiar with much of the market failure literature.

We'll need to wait a while to see if France's GDP at market exchange rates has overtaken's Britain's but some in Britain are already speculating on the prospect of parity between the Pound and the Euro, which currently costs 78p. Sarkozy was recently successful in persuading the National Assembly in France to repeal the ridiculous law setting a maximum working week of 35 hours introduced by Jospin's socialist government.

[Bob B]

Those who passionately believe the government should borrow more to invest in much-needed infrastructure may like to read this National Audit Office report on tramway systems:

NAO: Improving public transport in England through light rail (2004)
http://www.nao.org.uk/publications/nao_reports/03-04/0304518.pdf

Those of us who have worked in the public sector will probably be only too familiar with a species of fanatical tram ethusiasts embedded therein. Readers of the NAO report may like to focus especially on the egregious example in the report of the Sheffield Supertram, built at a cost to the public purse of some £200 + million and which was eventually privatised on receipt of just £1 million.

IMO it is to the undying credit of Alistair Darling, during his time as transport minister, for reining back the unbridled departmental enthusiasm for trams.

Least readers suppose I'm just prejudiced against trams, on the cover of the NAO is a pic of the Croydon tramway system which does serve a valuable transport function. That is because the commuter rail infrastructure in south London is typically radial and the sub-region is badly under-served by east-west and circumferential infrastructure. To its credit, the present government has approved the construction of the Crossrail link between Heathrow and Canary Wharf at an estimated cost of £16 bn:
http://news.bbc.co.uk/1/hi/business/7021945.stm

The development of Croydon as a major office centre with a fast rail link into Victoria alleviates the pressure on central London and traffic congestion there.

Btw the department of transport's enthusiasm for trams pre-dates by years the accession of the New Labour government in 1997.