The latest fiscal pledges from Sajid Javid and John McDonnell are similar in some respects, but very different in others. In short, both are planning to ramp up government spending, especially on investment, and have proposed new fiscal rules which should allow them to do so. However, Labour’s plans are much bolder – verging on reckless.
In contrast, the Financial Times has reported that ‘Number 10 advisors’ are angry that Javid’s new rules would still keep a relatively tight lid on borrowing. I don’t know if this report is true, but, like many others, I would actually welcome the retention of at least some fiscal discipline.
The similarities first. Both Labour and the Conservatives would aim to balance the current budget, i.e. the gap between tax revenues and day-to-day government spending. This would allow more borrowing than under the previous rules, provided it is for investment. Treating investment separately does makes some sense, because capital spending generally has a more positive impact than current spending on long-term economic performance. Interest rates are also currently low and the rest of the economy is sluggish, so this is potentially a good time to borrow.
Both Labour and the Conservatives would also introduce a new rule in the form of a ceiling for debt interest payments as a percentage of tax receipts. If this ceiling is breached, the government would be supposed to respond by reducing borrowing. (Actually, I’ll believe that when I see it.) But here is where the differences start: Labour’s ceiling is much higher, at 10%, compared to 6% for the Tories, and more than twice the current figure.
This reflects Labour’s plan to borrow a lot more ‘to invest’. The Tories will limit borrowing for this purpose to about 3% of GDP. Public sector net investment has been running at around 2% of GDP, so that would allow an additional 1% of GDP for capital spending – perhaps £22bn in the first year, and more than £100bn in total over five years. That should be more than enough to make a significant difference to the quality of infrastructure and public services.
What’s more, assuming normal economic growth, Javid’s 3% rule should also still be tight enough to stabilise debt as a share of GDP. That’s important. The UK has had higher levels of debt as a share of GDP in the (distant) past, but we are already pushing our luck, particularly given the increasing financial burden of an ageing population.
In contrast, Labour has pledged to invest an additional £400bn (on top of its many other commitments): £250bn over ten years and an additional £150bn in the first five years, averaging out at £55bn in each of those first five years. This would be roughly double what the Tories are proposing.
Labour’s rules would allow for this by shifting the focus to ‘public sector net worth’. In principle, this means that any amount of increased borrowing could be acceptable as long as it is matched by the creation or purchase of an offsetting asset (including non-financial assets, such as infrastructure). This is partly a nod towards Labour’s plans to spend large sums on bringing privatised utilities back into public ownership. And unusually, it’s not completely economically illiterate.
Nonetheless, this approach is hugely risky. Borrowing is still borrowing, whatever it’s for, and someone has to be willing to buy and hold the new government debt. Interest rates will not remain low for ever, especially if the Bank of England judges that a substantial fiscal stimulus reduces the need to keep monetary policy as loose as it is now.
Risk premia are also likely to rise. Investors are already worried by Labour’s broader economic agenda – including higher taxes, increased state control or wages and prices, and attacks on property rights. The world’s biggest bond fund, PIMCO, has already fired a warning shot. It will be interesting to see more from the credit rating agencies too.
Finally, there’s no guarantee that any new public sector assets would justify their valuation, or keep their value, under Labour management. The track record of all governments here is not encouraging, especially for large-scale infrastructure projects. Indeed, there are only so many good investment opportunities at any one time. The greater the spend over a relatively short period, the bigger the risk that borrowing is ploughed into less worthwhile projects.
Overall, then, I do think that it’s right for the next government to borrow a little more. However, if you had expected me to conclude that the Tories’ plans look far more responsible than Labour’s, you were right.
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