Credibility deficit

Ed Balls has chosen to take a different approach to spending to that adopted by Labour prior to 1997. He is right to do so, says Jonathan Todd

From the bully pulpit of the Treasury, George Osborne is convinced that he can have the deficit dominate the next parliament as it has dominated this – and, in so doing, keep himself resident in Downing Street and Labour stewing in opposition.

Since losing the general election, the deficit has sat alongside immigration and welfare as issues on which Labour is considered weak. The chancellor of the exchequer never misses an opportunity to attack these vulnerabilities. But he increasingly strains credulity in doing so. Amid hyperbolic chatter of saving the UK from a fate worse than Greece, Osborne unveiled his ‘emergency budget’ in June 2010. Many commentators accepted his claim that the pace and scale of his cuts were necessary.

The chancellor now proposes to run a surplus by 2018-19. In various senses, in contrast to much of the reception for the budget of June 2010, the necessity of this is queried. Chris Dillow of Investors Chronicle, for instance,  points out that we would not need to run a surplus to reduce national debt. If responsible debt management is our aim, therefore, it does not follow that this is best achieved by running a surplus.

As well as questions about its desirability, there are also doubts about the deliverability of a surplus in 2018-19. Polly Toynbee reports that Paul Johnson, head of the Institute for Fiscal Studies, is clear that he does not believe Osborne’s figures projecting to a surplus. In early January, the chancellor confirmed that these projections contain an additional £25bn of cuts between 2015-16 and 2018-19 – half of which would come from welfare payments to working-age people.

This fiscal trajectory takes us to within touching distance of the general election after next. That which Ken Clarke set as chancellor in advance of the 1997 election ran to the midpoint of the subsequent parliament. By setting a tough fiscal benchmark, he tempted Labour to run against it. Tony Blair and Gordon Brown declined to do so, both when campaigning for the general election and then in government. This fidelity bemused Clarke, as he confessed that he would have breached his own spending envelope had he continued as chancellor after May 1997. Consequently, Clarke’s fiscal plan did not amount to the policy that he thought best for the economy and public finances but a political ruse, an attempt to draw Labour into a position that, granted the authority of being the Treasury’s voice, he could deride as reckless.

The current chancellor may now be attempting a more extreme version of the same tactic. He is promising something, a surplus by 2018-19, that Johnson, the embodiment of sober analysis, does not believe can be delivered. Perhaps he is doing so because he does not really intend to deliver what he promises. Instead, his motive mirrors that of Clarke in 1997: tempt the Labour opposition into rejecting his fiscal path and then condemn it as dangerously unreconstructed.

Ed Miliband and Ed Balls have indicated that they will respond to Osborne differently from how their old boss reacted to Clarke. Balls spoke of surplus in his speech to the Fabian Society in January but in a different sense from Osborne. Where Brown stared down Clarke, matching each and every painful step, the shadow chancellor wants longer to do less than Osborne.

While Osborne promises a surplus by 2018-19, Balls commits to achieving one by the end of the next parliament. And what the shadow chancellor promises only relates to current spending. As Brown came to meet his ‘golden rule’ by redefining the business cycle, Balls would be assisted towards his surplus by redefining spending as capital, not current, spending. It could be argued, for example, that preventative spending, a form of investment which Miliband’s recent public service reform speech praised, should be so reclassified.

Balls has, consequently, left himself wiggle-room. As much as this deviates from the successful strategy of Brown in defeating Clarke, it may be prudent for the shadow chancellor to do so. Polling for Labour Uncut prior to Labour party conference explored how voters would respond to Labour promising to keep most of the present government’s spending plans while also pledging to borrow more for public works such as building homes. This, which now amounts to Balls’ position, proved to be a more popular approach than matching all of the government’s cuts.

The political strength of this position exists both in the popularity of investment such as in housing, and in the fact that if this investment increased the economy’s growth potential it would also reduce the size of the consolidation required to balance the books. The IFS noted in its Green Book earlier this year that the size of the output gap – the difference between actual GDP and potential GDP – is crucial.  The larger the output gap, the smaller the consolidation needed to balance the books. If you believe, as the Office for Budget Responsibility does, that there is an output gap of 1.8 per cent, this implies a total fiscal consolidation of £88bn being required to run a surplus in 2018-19. But if, like Capital Economics, you estimate the output gap at six per cent, then only £40bn would be required, implying no extra cuts would be needed in the next parliament to return the deficit to pre-crisis levels.

It is not necessary to be as optimistic as Capital Economics about the UK’s growth prospects to realise that infrastructure has become vital to it. It is a key point of political difference between it and the Conservatives, while also being a policy tool capable of raising the UK’s growth rate and thus reducing the extent of cuts required to meet Balls’ commitment to run a surplus.

The shadow chancellor has pledged to implement the findings of John Armitt’s review for Labour on long-term infrastructure planning if the party returns to government. What this will mean in terms of bricks and mortar, new jobs and new industries, needs to be convincingly set out before May 2015.

But if Labour is returned to government, no matter what boost to growth investment may generate, tough choices will confront it.  The OBR expects a surplus in 2018-19 but alongside public sector net debt of nearly £1.6tn or 76 per cent of GDP. Such a level of debt is associated with substantial annual debt interest payments and vulnerability to interest rate movements, constraining government policy for years to come. This debt requires responsible management, rather than making a fetish of running surpluses, which may not be the best way to reduce the debt. Duncan Weldon of the TUC and Nick Pearce of IPPR have both argued that a debt-to-GDP ratio should be targeted.

If Labour were to adopt such an approach to debt in government, it would not evade the need for difficult decisions but it would create a framework within which it would be incentivised to combine public and private resources to maximise growth. Thus, it would assist in creating what the pamphlet In the Black Labour called an enterprise state, in contrast to a welfare state. Making the case for fiscal conservatism, it argued that ‘welfare mechanisms are never preferable to a genuinely productive and balanced economy that raises the living standards of those on low and middle incomes.’

In many senses, the debate on running a surplus in the next parliament does not address the real challenges of creating such an economy. In itself neither does targeting a debt-to-GDP ratio. But it at least focuses the energies of government in this direction. Nonetheless, this is a more nuanced argument than Osborne’s blunt insistence on the need and deliverability of surplus in 2018-19.

The context of economic recovery may result in the public giving Osborne the benefit of the doubt, as they have done throughout this parliament, even when the economy was performing much more weakly. As difficult as Labour’s fiscal inheritance may be in May 2015, winning the public debate before then could be an even bigger challenge.

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Jonathan Todd is a contributing editor to Progress and chief economist at Demos

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Photo: HM Treasury

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