Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday 22 November 2021

Cancellation of rail projects in Northern England shows why fiscal rules with investment caps and debt targets just create short-termism


As Stephen Bush outlined here, and I foreshadowed here, the reason why the new high speed Northern Powerhouse Rail line has been cut, HS2 will no longer go to Leeds, and the less newsworthy cuts to Tfl infrastructure projects, is the government’s 3% cap on public investment, and its determination that government debt will be falling once the pandemic is over. [1] The excuse of long delivery periods for the cancelled projects does not wash when the government’s current scaled back plans also have the same long implementation period.

Is there some reason why public investment should be held to 3% of GDP? In my primer on fiscal rules I wrote nearly two years ago, I wrote:

“Public investment should not be part of any deficit target. To abandon good investment projects to reduce the deficit is a cure worse than the disease. The best way to stop white elephant investment projects is not some arbitrary limits on the share of investment to GDP, but an infrastructure commission with some power.”

In other words investment caps in fiscal rules should be thrown in the bin for a country like the UK. These caps make no economic sense and can actually do a lot of harm. Investment projects should be judged on an individual basis, and it makes no sense to cut or delay a good investment project because of some arbitrary aggregate cap. This isn’t a controversial point and there should be no serious economic debate about this.

So why do we have these caps? To answer that we need to go back into the history of UK fiscal rules. It has long been accepted that the primary fiscal target should be the current deficit, which is the total deficit less public investment. The reason is that a target for the total deficit encourages governments to cut investment to meet fiscal rules, because cutting investment does not have a direct impact on voters compared to cutting spending or raising taxes. Note there is no reason why the current deficit target has always to be a zero balance.

But if you have a current balance target, it is in theory possible for debt to GDP to rise because of high levels of public investment. In the past governments have got around that by having some form of debt to GDP target, either by having some upper limit or by saying debt has to be falling at some point. Another way to do this is to have a cap on the public investment to GDP ratio. This government does both.

If you have followed so far, you should have stopped at the first sentence in the last paragraph. You should have asked why does it matter if debt does rise because of a lot of public investment. Provided the individual projects within the public investment total are worth doing (either on a cost/benefit basis or some wider strategic basis like levelling up), debt should rise and there is nothing wrong with it rising. In short, borrowing to invest in good projects makes sense, as anyone running a firm will tell you. That is why it makes more sense to think about public net wealth rather than public debt.

Despite the obvious wisdom of this statement, there seems to be a political imperative for UK governments to say that the debt to GDP ratio is falling before the next election. The perception, encouraged by past politicians and the media, that government debt is somehow bad, leads Chancellors wanting to claim debt to GDP will be falling under their watch. Even political parties that received the best macroeconomic advice felt politically compelled to have some ‘falling debt’ provision in their fiscal rule. This perception goes back a long way, and is at least partly responsible for the extensive use of PFI under the Labour government. To ensure debt is falling, even when you meet your current deficit rule, you need to control public investment.

All of this is madness, stemming from Treasury orthodoxy and strengthened by Osborn’s fatal austerity programme. Some future government or opposition needs to be brave [2], and break this cycle of feeling some imperative to target government debt to GDP, and therefore control public investment to meet some arbitrary fiscal rule that makes no economic sense. Arguments about debt being a burden on future generations just do not apply to debt rising because of public investment, because public investment benefits future generations!

The main point of a fiscal rule is to stop an irresponsible government persistently paying for current spending or lower taxes by borrowing for no good reason. [3] It is to stop, for example, Donald Trump and Congress cutting taxes on the rich by increasing borrowing. You can do that by having a rolling aggregate current deficit target for 3 or (better) 5 years ahead, together with a strong fiscal council that can call out accounting tricks and other dodges. You do not need anything else in periods when interest rates are well above their lower bound. (The reason why you need a different rule when rates look like hitting their lower bound I discuss most recently here.)

A further point, made in Portes and Wren-Lewis, is that including anything involving a stock variable (like debt or net wealth) in a fiscal rule is a bad idea. The whole point about government debt is that it should act as a shock absorber for macroeconomic or fiscal shocks. Putting the stock variable in a short term rule negates that. Instead desired paths of net wealth should inform the value of the current deficit the government targets.

As the recent cuts to Northern rail plans show, this isn’t some academic (as in largely pointless) issue. It is one reason why governments appear excessively short-termist when it comes to its own investment projects. Start, stop, start again, stop again and so on. If the project does eventually get done it is long delayed and probably much costlier as a result of the on/off way it happened.

These broken promises put the government’s rhetoric on levelling up into perspective. At least as important, they make greening the economy much more difficult. Greening the economy is a mission, and missions of this kind require governments to take the lead. That requires a considerable amount of green public investment. The Chancellor, and the government more widely, has yet to indicate that he takes this mission seriously through actions rather than words. [4]

[1] As these project mainly involve spending in the 2030s, it’s not the current 3% rule that limits it, but a similar limit imposed by the Treasury on infrastructure projects given to the infrastructure commission, as Giles Wilkes points out here

[2] The Labour party in 2019 did replace debt with net government wealth, but as I argue below while this is better than debt it isn't a good idea for other reasons.

[3] What are good reasons to spend more on day to day expenditure than the revenue the government receives? A downturn in the economy is the obvious reason, but it is not the only one. A persistent but certain temporary drop in tax receipts would be another.

[4] Any Chancellor who was serious about greening the economy would increase petrol duty, for a start. Over the last few decades the costs of going by train has increased a lot more than the cost of driving by car.

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