As the chancellor considers how to reform the fiscal rules to enable more investment, a guest post by John Crompton on the potential dangers in some of the proposals and which one she should choose
Great post and completely agree on the net worth argument
In all this I do think that the whole budget fear situation is overblown. It’s a great opportunity to set out new more sensible fiscal rules that prioritise investment but the idea that Labour will introduce a budget that will push all capital out of the country seems crazy - it completely contrasts with the close to business platform, Reeves conference speech, the manifesto etc.
Reeves would have to deliver an absolutely horrible (economically/markets wise) budget that stinks of short termism to deliver on fears which seems so unlikely (eg tax business/investment and massive increase in current spending)
Instead, hopefully we get a shift towards a more sensible fiscal framework (maybe alongside recategorising APF flows which I think investors would swallow), and then the tax and spend changes themselves would be modest (no big 4 changes on the former and prioritising investment on the latter, probably slightly more borrowing)
I agree, I suspect that is what we will get, though I think as per John's previous post, it will be a missed opportunity to introduce a net worth based framework. Personally, I don't see net worth as a way to increase borrowing, as it is being presented by some commentators. Quite the opposite, it is a way to reduce debt over time, in part through greater transparency about the state of the balance sheet - which is why ultimately Reeves may shy away...
Makes sense! Even if they do decide to roll something out and it hypothetically did increase ability to borrow (not close to the details but I can see why it wouldn’t), surely this would take quite some time to setup - not exactly going to unlock a big bucket of cash for Reeves today (although could help with them in infra spending in latter half of the term)
An interesting article, persuasive of the superiority of the net worth measure of fiscal sustainability, but it doesn’t tell us what fiscal rule is being proposed.
Thanks Alasdair. John will have his own thoughts on the fiscal rule, and perhaps will respond here. But I think there is a lot to be said for the approach suggested by Richard Hughes in a paper for the Resolution Foundation written before he became chair of the Office for Budget Responsibility which I cited in a previous post on this topic. He advocated a new fiscal framework which included a net worth “objective” to improve public sector net worth as a percentage of GDP over five years alongside a structural current budget balance “target” and a debt interest ceiling to ensure borrowing remained affordable. What do you think?
This is not my area so I don’t have view but I’d expect a piece with “fiscal rules” in the title to have some discussion of the implications for fiscal rules.
My primary concern is that the overall framework for running our public finances (including, but not limited to, "fiscal rules") should be grounded in accrual accounting, under which the primary measure of the financial position at a point in time is Net Worth. This is important for several reasons: the dangers to fiscal sustainability associated with managing to targets with a more limited scope; the tendencies of debt and cash-focused fiscal rules and financial management systems (like the one we've got) to incentivise current versus capital expenditure, and the attendant implications for intergenerational fairness; the very substantial opportunities for better asset and liability management that are opened up under Net Worth based fiscal rules, informed by accrual accounting. This is the focus of what is necessarily quite a short article, written in response to similarly broad discussions of alternative fiscal frameworks.
As you rightly point out, there is a very interesting discussion to be had about the details of such a proposal, which would need to address two questions:
1. What would a full set of fiscal rules look like? On this I would defer to my "Public Net Worth" co-author Ian Ball, who set up New Zealand's accounting-driven financial management framework some 30 years ago and under which the country has transformed its financial position despite multiple natural disasters and COVID. But certainly there need to be multiple rules, which in the case of New Zealand cover revenue, spending and debt levels, within the overall framework which seeks to achieve and maintain targets levels of Net Worth.
2. Within these rules, what targets should be set? It's all very well to have a sensible framework, but to be effective it will be necessary to set targets which are are sufficiently challenging to be credible given the long term demographic challenges to public finances, which are described by long term projections (eg the OBR Financial Sustainability report) rather than being captured by current measures of the financial position.
To offer an example which spans both topics: the Labour Party manifesto contains a commitment that current expenditure and revenue should be balanced by the end of the current parliament. This is quite a long adjustment period in my view, but it also ignores two important realities. First, that under current fiscal rules unfunded pension entitlements do not count in the measure of current expenditure yet amount to around £100 billion per year, or over 3% of GDP so "balance" is rather a relative term. Second, that a fiscal adjustment of 4-5% of GDP is needed for 50 years starting now to address the demographic impact on government income and expenditure according to the OBR; "balancing" the current account in five years doesn't get close. (Incidentally there is some overlap between these two sets of figures, so they shouldn't be added together).
Net Worth-based fiscal rules/targets would necessarily take pension accruals into account, a commitment to "balance" revenue and expenditure would be a lot more meaningful than under the current framework. But to be effective in promoting fiscal sustainability fiscal targets would need to be set in the light of the long-term projections as well, and run an appropriate level of surplus to meet these.
Now my turn for apologies for a slow (slower) response. Your point about the fact that the present current balance rules ignore unfunded pension liabilities is a good illustration of how fiscal rules change on a net worth approach. The OBR demographic argument is a different issue, about whether the current balance rule should be changed so present taxpayers contribute to their own old-age costs as well as the costs of the currently retired: not directly a net worth issue.
Monetarily sovereign governments always have choices
Fiscal guardrails have varied from balanced budgets, to modest deficits, to stable or declining debt-to-GDP ratios, differences that encompass tens of billions of dollars. Their commonality is that all are arbitrary, and designed ideologically to limit government spending.
Our children are threatened by lack of job opportunities, growing inequality, a fragile health system, and potential food and environmental crises arising from climate change. Solutions will require urgent action and should not be hamstrung by what are merely statistical artifacts.
Monetarily sovereign governments own central banks and should use their fiscal powers to ensure mobilization of all available societal resources for the well-being of its citizens. Listen to economist John Maynard Keynes: "Anything we can actually do, we can afford."
Footnotes:
1. British productivity slump – all down to George Osborne’s austerity obsession
"Continue to rave on about fiscal rules (as if they define responsible policy) or grow up and recognise the intrinsic capacities its had as the currency-issuer to create strong employment growth and first-class public infrastructure – both of which crowd in private investment."
Great post and completely agree on the net worth argument
In all this I do think that the whole budget fear situation is overblown. It’s a great opportunity to set out new more sensible fiscal rules that prioritise investment but the idea that Labour will introduce a budget that will push all capital out of the country seems crazy - it completely contrasts with the close to business platform, Reeves conference speech, the manifesto etc.
Reeves would have to deliver an absolutely horrible (economically/markets wise) budget that stinks of short termism to deliver on fears which seems so unlikely (eg tax business/investment and massive increase in current spending)
Instead, hopefully we get a shift towards a more sensible fiscal framework (maybe alongside recategorising APF flows which I think investors would swallow), and then the tax and spend changes themselves would be modest (no big 4 changes on the former and prioritising investment on the latter, probably slightly more borrowing)
I agree, I suspect that is what we will get, though I think as per John's previous post, it will be a missed opportunity to introduce a net worth based framework. Personally, I don't see net worth as a way to increase borrowing, as it is being presented by some commentators. Quite the opposite, it is a way to reduce debt over time, in part through greater transparency about the state of the balance sheet - which is why ultimately Reeves may shy away...
Makes sense! Even if they do decide to roll something out and it hypothetically did increase ability to borrow (not close to the details but I can see why it wouldn’t), surely this would take quite some time to setup - not exactly going to unlock a big bucket of cash for Reeves today (although could help with them in infra spending in latter half of the term)
An interesting article, persuasive of the superiority of the net worth measure of fiscal sustainability, but it doesn’t tell us what fiscal rule is being proposed.
Thanks Alasdair. John will have his own thoughts on the fiscal rule, and perhaps will respond here. But I think there is a lot to be said for the approach suggested by Richard Hughes in a paper for the Resolution Foundation written before he became chair of the Office for Budget Responsibility which I cited in a previous post on this topic. He advocated a new fiscal framework which included a net worth “objective” to improve public sector net worth as a percentage of GDP over five years alongside a structural current budget balance “target” and a debt interest ceiling to ensure borrowing remained affordable. What do you think?
This is not my area so I don’t have view but I’d expect a piece with “fiscal rules” in the title to have some discussion of the implications for fiscal rules.
Apologies for slow response, but a few comments:
My primary concern is that the overall framework for running our public finances (including, but not limited to, "fiscal rules") should be grounded in accrual accounting, under which the primary measure of the financial position at a point in time is Net Worth. This is important for several reasons: the dangers to fiscal sustainability associated with managing to targets with a more limited scope; the tendencies of debt and cash-focused fiscal rules and financial management systems (like the one we've got) to incentivise current versus capital expenditure, and the attendant implications for intergenerational fairness; the very substantial opportunities for better asset and liability management that are opened up under Net Worth based fiscal rules, informed by accrual accounting. This is the focus of what is necessarily quite a short article, written in response to similarly broad discussions of alternative fiscal frameworks.
As you rightly point out, there is a very interesting discussion to be had about the details of such a proposal, which would need to address two questions:
1. What would a full set of fiscal rules look like? On this I would defer to my "Public Net Worth" co-author Ian Ball, who set up New Zealand's accounting-driven financial management framework some 30 years ago and under which the country has transformed its financial position despite multiple natural disasters and COVID. But certainly there need to be multiple rules, which in the case of New Zealand cover revenue, spending and debt levels, within the overall framework which seeks to achieve and maintain targets levels of Net Worth.
2. Within these rules, what targets should be set? It's all very well to have a sensible framework, but to be effective it will be necessary to set targets which are are sufficiently challenging to be credible given the long term demographic challenges to public finances, which are described by long term projections (eg the OBR Financial Sustainability report) rather than being captured by current measures of the financial position.
To offer an example which spans both topics: the Labour Party manifesto contains a commitment that current expenditure and revenue should be balanced by the end of the current parliament. This is quite a long adjustment period in my view, but it also ignores two important realities. First, that under current fiscal rules unfunded pension entitlements do not count in the measure of current expenditure yet amount to around £100 billion per year, or over 3% of GDP so "balance" is rather a relative term. Second, that a fiscal adjustment of 4-5% of GDP is needed for 50 years starting now to address the demographic impact on government income and expenditure according to the OBR; "balancing" the current account in five years doesn't get close. (Incidentally there is some overlap between these two sets of figures, so they shouldn't be added together).
Net Worth-based fiscal rules/targets would necessarily take pension accruals into account, a commitment to "balance" revenue and expenditure would be a lot more meaningful than under the current framework. But to be effective in promoting fiscal sustainability fiscal targets would need to be set in the light of the long-term projections as well, and run an appropriate level of surplus to meet these.
Scope for future pieces, maybe!
Now my turn for apologies for a slow (slower) response. Your point about the fact that the present current balance rules ignore unfunded pension liabilities is a good illustration of how fiscal rules change on a net worth approach. The OBR demographic argument is a different issue, about whether the current balance rule should be changed so present taxpayers contribute to their own old-age costs as well as the costs of the currently retired: not directly a net worth issue.
Monetarily sovereign governments always have choices
Fiscal guardrails have varied from balanced budgets, to modest deficits, to stable or declining debt-to-GDP ratios, differences that encompass tens of billions of dollars. Their commonality is that all are arbitrary, and designed ideologically to limit government spending.
Our children are threatened by lack of job opportunities, growing inequality, a fragile health system, and potential food and environmental crises arising from climate change. Solutions will require urgent action and should not be hamstrung by what are merely statistical artifacts.
Monetarily sovereign governments own central banks and should use their fiscal powers to ensure mobilization of all available societal resources for the well-being of its citizens. Listen to economist John Maynard Keynes: "Anything we can actually do, we can afford."
Footnotes:
1. British productivity slump – all down to George Osborne’s austerity obsession
https://billmitchell.org/blog/?p=37118
"Continue to rave on about fiscal rules (as if they define responsible policy) or grow up and recognise the intrinsic capacities its had as the currency-issuer to create strong employment growth and first-class public infrastructure – both of which crowd in private investment."