When I started writing this paper with Jonathan Portes, I was genuinely unclear about whether fiscal targets should be for the total deficit (which includes public investment) or for the current balance (which excludes it). This was partly because some of the conventional reasons for excluding investment seemed poor. For example, to assume all investment paid for itself in the form of higher activity and therefore higher taxes is obviously wrong. To avoid this by having each project treated on its own merits (it would happen if it generated a social return greater than some cut-off or interest rate) is better but ignores the uncertainties that any such calculation inevitably involves.
By the time the paper was finalised, and later when it came to proposing a rule that the Labour party could adopt, it was clear to me that any target should be for the current balance, with a separate target for the public investment to GDP ratio. We can see a very strong argument for doing that right now. Jean Pisani-Ferry is one of a steady stream of economists saying that it really is time to increase public investment, and they are backed up by international organisations. But despite all this being true for some time, there is very little sign of governments taking much notice. As Pisani-Ferry notes: “On average, governments are using the gains implied by lower interest rates to spend a bit more or to reduce taxes, rather than to launch comprehensive investment programs.”
The political economy reason why this is happening is straightforward enough. When both current and capital spending have been squeezed for some time, if this constraint is partially relaxed governments have a choice. Public investment generally benefits future generations as well as voters today, while current spending all goes to the current generation. Governments who aim to maximise votes for themselves will therefore tend to ignore investment spending.
Exactly the same process happens in a recession. It is generally easier and less painful to cut an investment project than fire some nurses or teachers. The danger with deficit targets is therefore than whenever these targets bite, public investment is the first to suffer. This is exactly what happened in the UK in 2010 and 2011, which accounted for a great deal of the deflationary impact of the Coalition government’s fiscal consolidation.
Those in the know will point out that the Coalition’s main fiscal target was for the current balance. That is why it is vital to also have a separate target for the public investment to GDP ratio. That would ensure that over the next few years governments do not just pretend to do something about infrastructure and other public investments by funding one or two high profile projects, while continuing to keep overall public investment low. That is what George Osborne did, with planned investment over the next five years between 1.5% and 1.9% of GDP. If Philip Hammond does not change these plans to something more like 3%, we will have another Chancellor who talked the talk on investment but is not prepared to put money where his mouth is.