The next UK government’s economic policy will be determined by the constraints of its self-imposed ‘fiscal rules’. Fiscal rules protect citizens from using public credit cards to further their own ends, such as by circumventing real choice discipline or bribing voters with tax cuts before elections. designed to protect. But poorly designed rules can be damaging.
UK public sector investment has lagged behind its competitors for more than 15 years. It is also the second most unstable country among developed countries. Businesses are turning their backs on Britain, partly because the country’s public infrastructure is crumbling, and private investment as a share of income is lower than in almost any other major economy.
Fiscal rules are at the heart of this issue. There is no such thing as a certain amount of “fiscal space” to promote good investment. Debt is not a “burden” if it is used to finance resilient productive assets rather than consumption.
Governments create fiscal space by encouraging investment in core public assets that generate future returns. The alternative is that the soft targets for achieving the austerity plan are public investment, which hurts the UK’s productivity growth, erodes future tax revenues, and leaves us in a doomed loop of austerity that requires further austerity. That’s true. Partly as a result, the UK has experienced two decades of low investment, low growth and stagnant wages, almost uniquely among its major competitors. Like the nation’s schools, the fiscal ceiling is crumbling.
Many people are currently suing to borrow money to invest, but they feel the need for some kind of public debt rule, so the government has a blank check to invest unlimited public funds. Not given. But after two decades of systemic underinvestment, fears that governments are spending too much on infrastructure and skills seem rather misplaced.
The value of an investment strategy to the economy has nothing to do with the amount of debt. It’s either a good strategy that the market should support, or it’s not. The idea that we don’t have the luxury of planning for growth is self-contradictory. Fixing or lowering long-term debt/GDP targets would act as a “lower public investment” rule and would clearly conflict with the UK’s immediate public investment requirements.
However, the UK faces other structural macroeconomic problems. For decades, the country has saved less of its national income than nearly all advanced economies. It is also not enough to fully meet relatively subdued investment demand. Increasing investment without increasing domestic savings necessarily requires increasing borrowing from abroad. This creates vulnerability to shocks, means retirement savings are inadequate for many people, and returns on investments in the UK accrue to overseas investors. Instead of funding its own spending, Britain increasingly relies on the kindness of strangers.
With little headroom in the economy, additional investment will crowd out alternative investments, creating inflationary pressures and prompting the Bank of England to raise interest rates, unless steps are taken to rein in consumption and encourage savings. We need to face the reality of the UK’s public service needs, including stress on social care and the NHS, an aging population and increased funding for defense spending. For the time being, taxes will need to remain higher than in the past to cover current spending. In the long run, returns must come from investment rather than consumption.
what will you do? Rules that reduce the public debt-to-GDP ratio over the medium term should be abolished. This arbitrary constraint is the main reason why much-needed investments tend to be cut whenever public finances tighten.
It makes a lot of sense to finance government consumption with sufficient and strong taxes (current fiscal balance, or “golden rule”) while protecting public borrowing for net investment only. Indeed, it would be possible to introduce a simple tightening rule that requires a small surplus in the current budget over the entire business cycle. Governments will likely try to effectively compensate for the decline in household savings by reducing borrowing for consumption, allowing for increased investment without excessive borrowing from abroad. In an economy with limited productive capacity and inflationary pressures, current consumption must be squeezed out to make room for investment.
The size of this target surplus can be determined with support from the OBR and can be reduced if structural measures such as stronger automatic enrollment into employee pensions are successful in increasing UK savings, or if AI and machine learning improve revenue collection. . Such rules mean that in growing economies, even after increasing public investment, public debt-to-GDP ratios decline on average over the cycle, leading to other nasty surprises like coronavirus or Ukraine. This must mean leaving a buffer for responding.
Markets understand that not all debt is created equal, and the UK is underpinned by a strategy that takes seriously the crucial difference between investment and consumption spending and enshrines this in fiscal rules. They are unlikely to demand a higher risk premium for public borrowing. Such a strategy increases the sustainability of public debt.
Fiscal rules serve to end short-termism in the economy. Sensible fiscal discipline is sound economics, but fictitious application of arbitrary and counterproductive rules is not. Chronic underinvestment has left the UK with macroeconomic instability, stagnant living standards and one of the lowest productivity of any major economy. New fiscal rules are needed not to reduce long-term investment, but to limit political discretion.
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