The campaign against Labour borrowing to invest

 

One of the positive highlights of Labour's economic plans that I discussed last week, investment of £28 billion a year in greening the economy, has been scaled back. That figure will now only be achieved in the second half of a Labour government’s first five years. One reason given is that it will take time to get such investment going, which sounds reasonable but raises the question of why this point wasn’t understood when the original policy was announced.

Unfortunately the announcement has also been explained in terms of Labour’s commitment to meeting its fiscal rules, and the poor state of the economy created by the Conservatives. This echoes a campaign that has been getting an increasing amount of press, even in the neutral and sympathetic (to Labour) media.

So in the FTs recent analysis of Labour’s economic programme, we find this quote from Mike Riddell, a global bond fund manager at Allianz Global Investors: “Any additional unexpected borrowing risks another gilt meltdown.” Unexpected? Riddell says they have not been fully “priced in” by investors and could make investors “jittery” as they become headline news. If you believe that you will believe anything (as many people did in 2010).

Or this from New Statesman editor Jason Cowley, in an article on Reeves:

“Miliband led Labour to defeat in 2015 and concern is growing that he has inadvertently set a trap for his party – because Starmer and Reeves have not explained how they would fund the proposed £28bn a year for capital spending on green growth”.

In reality it is clear that public investment will be matched by additional borrowing, not higher taxes. The IRA in the US was financed from taxes because of daft budget rules imposed by Congress.

That Labour have partly succumbed to this campaign is bad news for two main reasons. First, by implying that fiscal rules come before anything else, they elevate the importance of these rules way beyond any reasonable assessment. Are these rules really more important than the survival of the planet and avoiding another energy crisis? Second, it plays into some of the worst aspects of mediamacro, which uses adherence to fiscal rules (however daft those rules are) as a measure of economic responsibility, and takes talk of jittery bond markets far too seriously.

This all goes back to a contradiction in the fiscal rules set out by Rachel Reeves, and many before her (including John McDonnell). The contradiction is between the laudable attempt to have rules that distinguish between current public spending and public investment, and at the same time having a target for a falling debt to GDP ratio (which makes no distinction between debt used to fund investment or current spending). I have long argued that the falling debt to GDP target is a bad fiscal rule, but even John McDonnell felt he had to include it for political/media reasons against my advice.

Unfortunately, the campaign to reduce the amount Labour would invest in greening the economy will only be encouraged by this announcement, and a media obsessed with fiscal responsibility will continue with that obsession. Unfortunately, just as the Global Financial Crisis gave spurious credibility to scare stories about the UK being 'on the brink' in 2010, what happened to Liz Truss and Kwasi Kwarteng has done the same for those campaigning against a Labour government borrowing today. Virtually everyone in the media has taken what happened to the ill-fated ‘fiscal event’ in September 2022 to be evidence that the bond vigilantes are real and just waiting to pounce on any government that borrows too much, whatever that means or whatever that borrowing is for. Even some economists have done so. In this FT article, Philip Coggan is sensible enough to note that most of the time markets take increases in deficits in their stride, as long as a country has its own central bank. But just occasionally, he says, markets do worry about them. What evidence does he give for this? The Truss/Kwarteng fiscal event. We seem to be back to treating financial markets as a Vengeful God, who we have to appease just in case they are in a bad mood.

It was why I looked at that episode in great detail, arguing that the market reaction had nothing to do with the chances of UK default, and everything to do with uncertainty over the path for future interest rates. By announcing tax cuts without also announcing by how much and (crucially) when public spending would be cut, the impact on demand and therefore the reaction of the Bank of England became much more uncertain, raising the risk premium on UK assets. [1]

But such a story is way too complicated for anyone in our 24hr media circus, so far easier to think that markets were just reacting to more borrowing. This is even though Kwarteng was committed to reducing the debt to GDP ratio, and said that spending cuts would follow. Easier in part because you will always find economists (particularly in the City) to start talking about nervous markets, as we saw above.

It makes sense to borrow to invest. I get tired of writing this because it really should be common knowledge. Every economist worth their salt would agree with this. Even Rogoff, who encouraged 2010 austerity in the UK, made it clear that he didn’t mean cutting public investment. (A large part of austerity in 2011 and 2012 involved cutting public investment.) Investment benefits current and future tax payers, so it makes sense for future taxpayers to pay as well as current taxpayers. Firms borrow to invest all the time. Consumers borrow to invest in a house. Yet when it’s a Labour government, or a Tory government that wants to cut spending, then suddenly all this common sense goes out the window and we hear instead about market jitters. If you really think the Truss/Kwarteng crisis was about too much borrowing, note that they were borrowing for tax cuts, not investment in the future. [2]

But what should make any sensible person, and not just economists, angry is that this is a coordinated attempt to cut back on green investment. Investment that is vital to save our planet as we know it. What could be more important than that? What is more, this investment will have the added benefit of making energy cheaper, at a point when the UK has had its worst cost of living crisis in decades as a result of high oil and gas prices. The US government is spending large sums to get this done, and the EU is doing the same. What kind of nonsense says the UK shouldn’t do the same?

The Tories, whatever Labour say, are bound to talk about a 'borrowing bombshell' before and after the next election. A solid and convincing response is that Labour are only borrowing to invest, and investing in worthwhile public projects is essential for growth, and never fiscally irresponsible. What could be more essential than green investment to make energy cheaper, as the US and EU are doing? That is a clear line to take, and also happens to make good economic sense. If you can associate 'investment' with borrowing in voters minds you undermine a lot of mediamacro's rhetorical power. That could have been Labour's line to take. When the media say 'how do you know the markets will not turn on you like they did on Truss/Kwarteng', the answer is they were borrowing to fund tax cuts, while we are borrowing to invest, just as firms and home owners do. Unfortunately now Labour have said spending £28 billion on worthwhile investment in its first few years would have been fiscally irresponsible, and could damage the economy. They have undercut what would have been a sound defence in economic and political terms to the borrowing bombshell attack, and the 'what about the markets and Truss' attacks. Rather than shore up the £28 billion pledge, they have opened the door to further attack.

[1] Further uncertainty was created by the credibility (or rather lack of it) of any announced spending cuts, given the dire state of public services and public sector pay. The key bit of evidence here is that sterling depreciated. If the prospect had simply been higher interest rates, sterling would have appreciated.

[2] The claim that Kwarteng's tax cuts are not unlike Labour's £28 billion pledge because the former included incentives to invest does not stand up. Kwarteng's tax cuts were mainly (in £ terms) lower corporation tax and lower national insurance contributions. The latter does not encourage investment and the extent to which the former does is very uncertain.