10 June 2015

Q&A: What is George Osborne up to?


UK Chancellor George Osborne is announcing a new fiscal framework later today which binds this and any future government to reducing the nominal value of national debt through fiscal surpluses. The rule will be overseen by a new formation of the Commissioners for the Reduction of the National Debt – wheeled out for the first time since 1860 – and the Office for Budget Responsibility. Behind the spin, what is he up to?

What exactly is the Chancellor announcing?

Tonight, in his speech to the City of London at Mansion House, he will say that:

“With our national debt unsustainably high, and with the uncertainly about what the world economy will throw at us in the coming years, we must now fix the roof while the sun is shining,”

He will then call for:

“…a settlement where it is accepted across the political spectrum that without sound public finances, there is no economic security for working people; that the people who suffer when governments run unsustainable deficits are not the richest but the poorest; and that therefore, in normal times, governments of the left as well as the right should run a budget surplus to bear down on debt and prepare for an uncertain future.”

Is he moving the goalposts on deficit reduction?

We don’t know yet, but the suspicion is that under cover of a tough-sounding rule on deficits the timetable on reducing the gap between what the government takes in and spends is about to be adjusted. Those with longer memories and a cynical disposition will think back to 2007, when, in opposition, George Osborne promised to match Labour’s spending plans. He moves to the most politically fertile territory when it suits him.

Indeed, its preview coverage, The Guardian compares the Chancellor to Mr. Micawber, a Dickens character who preached staying out of debt but whose guiding principle to life was, “something will turn up”.  This confusing association is apt; we should wait for more details of the plan, as Newsnight’s Duncan Weldon remarked:

“Once the overall budget gets back into surplus, the government will be mandated to continue to run a surplus as long as the economy is growing, starting to pay down the national debt. That, we know. Here’s what we don’t know, which could be hugely important for the next few years. Does this new mandate replace the existing one, or is it in addition? The current mandate says they’ve got to balance the current budget by 2017/18. If they actually push that back to 2020, suddenly it becomes a lot easier. The rollercoaster becomes less steep, the welfare cuts become less deep, and what is sold that is something about being more austere, actually allows them a few years to be less austere.”

They say that to aid clarity, less is more. But when it comes to the game of artifice in public finances, more is very often less. After settling down after an election victory in which his party promised no rises in the three core taxes (income tax, national insurance and VAT), the Chancellor may have realised that his ability to eliminate the budget deficit in two years in a manner palatable to public opinion is rather limited, and that he would be better served by an act of rhetorical gymnastics in the hope that something good turns up, such as robust economic growth.

Why is he doing it now?

Labour is in a mess as it searches for a new leader and Osborne, ever the tactician, sees an opportunity to capitalise on the opposition’s distress early in the parliament. It may be true that fiscal frameworks rarely survive contact with a future economic downturn, but Osborne will worry about that later. For now, he ‎wants to hammer home that the Opposition is not trusted by voters on the economy and, as it stands, has no plan.

Is Osborne’s new framework economically credible? 

Last week, three economists at the IMF, Jonathan Ostry, Atish Ghosh and Raphael Espinoza, released a paper on debt dynamics. Its conclusion gives academic ammunition to the anti-austerity gang and to those who propose a smoother and more moderate deficit reduction plan.

“Advocates of ‘fixing the debt problem’ stress the crisis-insurance benefit, without mentioning the upfront cost of insurance,” Mr. Ostry said. “Insurance can be expensive in terms of the higher taxation needed to run a budget surplus.”

The paper is supported by a bulletin from Moody’s, a credit rating agency, showing that the “distance to debt limit” (see chart, below) for a number of advanced economies is larger than conventional wisdom would have it. That is not to say they should all go on a splurge, but it does mean that a number of countries could already have enough headroom to deal with another crash.


“For countries that have fiscal space, the cost of insurance is likely to be much larger than the benefit,” Mr. Ostry continues.

In other words, the IMF economists (who have been wrong before) claim that governments are better off borrowing to invest and improve the growth potential in the economy than being too hawkish about their debt-to-GDP ratios.

The mainstream academic consensus mostly takes this view. One of the leading advocates of it in the UK is Simon Wren Lewis, who in this post agrees that the national debt is too high but the path of adjustment needn’t be so quick, while Paul Krugman’s latest blog argues that his high-spending Keynesian prescriptions are temporary and not a ruse to permanently expand the scope of government.

That is the technocratic view. But there is nothing inherently just about high levels of borrowing and government debt. The cost will be substantially borne by younger generations, and as population demographics become increasingly unfavourable and the workforce shrinks in advanced economies, that cost will rise. Osborne is right to continue to make the case for crisis-insurance as well as reforms to the state so that it becomes smarter, leaner and more efficient.

Tonight, however, it looks as though we will see Mr. Micawber deliver a sleight of hand to his creditors at Mansion House. Let’s hope it doesn’t get him thrown into a debtors’ prison (again), and that something really good eventually turns up.

Zac Tate is Deputy Editor of CapX