The next time someone says the government cannot borrow to invest, just mention RAAC

 

Kids not being able to go to their normal school because those schools are crumbling away is as good an example as any of the impact of 13 years of austerity government. It began with Gove scrapping Labour’s Building Schools for the Future programme (a decision he subsequently said was one of the worst he made) when the Conservatives came to power in 2010, and it may well end with thousands of children being forced to relocate to temporary accommodation because Sunak when Chancellor failed to respond to warnings from his own Education department.

It is also an example of the impact bad fiscal rules can have. As I have argued many times, whether to undertake public investment (which can vary from large infrastructure projects to replacing crumbling concrete) should depend on the merits of the investment, and not on some arbitrary aggregate limits. Yet governments have at various times imposed fiscal rules that either included public investment (a target for the total deficit, or a falling debt to GDP target) or in some cases imposed a limit on total public investment itself. [1]

The case of crumbling schools caused by RAAC concrete also clearly shows why arbitrary aggregate limits on public investment make no sense. When the roof of a primary school in Kent collapsed in 2018, ignoring the problem became, in the words of the National Audit Office, a “critical risk to life”, which meant many schools with Raac concrete in them needed replacing fast. That means spending a lot of money quickly. As we now know, and as the Treasury were told, not doing so would mean some school buildings would become unsafe to use. Unlike current spending on day to day services, the need for public investment can vary substantially over time, and sometimes that investment just has to take place.

What did Sunak, or the Treasury, expect to happen when they revised down a RAAC based bid from their education department by a factor of 4? Were they crossing their fingers and hoping that the engineers were being over cautious, and that no more buildings would collapse? Or did they not even get as far as reading what the department had written, and instead just looked at numbers on a spreadsheet? Did no Treasury official raise their hand and say ‘but minister, what will happen when they start closing schools because they are unsafe’?

The term ‘Treasury brain’ is fashionable, but if the politicians in charge are determined to spend less public money then the Treasury can do little to stop them. Furthermore, these politicians are invariably short term in their political outlook, so they will always be tempted to cut investment rather than current spending. Investment by its nature has its benefits in the future, while current spending cuts will be noticed today. This is why it’s important to design fiscal rules that stop politicians doing this. If the Treasury can tell a minister that cuts to public investment will not do anything to help that minister meet their fiscal rules, they are less likely to make those cuts. [2]

The same is true for short term cuts that end up costing more in the longer term. Treasury brains are more than capable of seeing the foolishness of doing this, but if the remit from politicians is to get down borrowing over the next few years by whatever means possible, Treasury civil servants cannot keep options from politicians. Again fiscal rules need to be medium to long term, to avoid this kind of foolishness.

The whole current system, where dangerously crumbling concrete is kept in place because fixing it would require some borrowing, is predicated on a kind of deficit fetishism that treats reducing government borrowing as more important than almost anything else, including teaching children. Politicians are putting reduced borrowing ahead of essential investment. Asked why, they will mutter phrases like ‘fiscal responsibility’, and the media will find a City economist to talk about ‘bond market jitters’. Someone will mention the Truss fiscal event, as if borrowing to stop schools collapsing on children can be equated to cutting the top tax rate. (In reality the reaction to the fiscal event was all about interest rate uncertainty and pension funds taking risks rather than excessive government borrowing.)

Fiscal responsibility does have a real meaning. It makes sense to ensure taxation matches current spending in the long run so debt to GDP levels are sustainable. Fiscal rules are useful to prevent politicians cutting taxes or spending more to win elections and funding these giveaways by borrowing. But refusing to borrow to enable schools to remain open and safe is clearly not in any sense fiscal responsibility. For once household and firm analogies are appropriate. People borrow if necessary to fix serious problems with their homes, and firms would of course borrow to prevent their factories falling apart, so why not the government when it can borrow more easily and more cheaply than any household or firm?

However there is one area where aggregate conditions, rather than the individual merits of any investment, does matter. This is borrowing costs, which should influence when (not if) investment is done. The ideal time to start replacing RAAC concrete was when borrowing costs were almost zero, because short term interest rates were at their lower bound. Yet, as this graph from the IFS shows, this government cut capital spending on education compared to levels under Labour, just at the point when borrowing costs were at their lowest. Cutting investment when borrowing is cheap, and being forced to do the investment when borrowing costs are much higher, is a good example of this government’s economic incompetence.

This is one area where the way the Treasury does things may be lacking. Whether a project is worth doing is typically assessed using a constant 3.5% real discount rate, with some exceptions. There are good arguments for using a discount rate independent of market rates, although whether the rate should be as high as 3.5% is another matter. But deciding that public investment projects are worthwhile to do, and deciding when to do them, are two different choices. The latter will depend on many things, including the state of the economy and the cost of borrowing.

It is obviously cheaper for the government to undertake a worthwhile investment when the cost of borrowing is very low. Yet it is unclear how that basic point influences government spending decisions. Needless to say, a focus on reducing borrowing when the economy is depressed, and interest rates and borrowing costs are likely to be low, is completely the wrong thing to do. But even if that was not the case, it is not clear that Treasury practice encourages investing when it is cheap to borrow.

Closing schools because the government refused to replace crumbling concrete is also a perfect example of what this government has become in another sense. Before the 2020 spending review, Sunak as Chancellor was told by the education department that at least 300 schools needed replacing a year because of crumbling concrete, and they asked for funding to replace 200 a year in the first instance. Instead Sunk decided to halve the school rebuilding programme target from 100 to 50 schools per year. But when presenting the results of this spending review, he described it as producing a “once in a generation investment in infrastructure”. It’s not just that they lie all the time, but when Sunak like Johnson makes grandiose claims it is generally to disguise monumental failure.

Unless something unforeseen happens, we are destined for a year when all we can do is look forward to a change in government. An incoming Labour government may not have the same aversion to the public sector as this current lot, but they will still have fiscal rules. The government will still be working in a media environment where government borrowing is viewed with suspicion, and the distinction between how day to day spending and investment is funded is rarely made. Labour are committed to borrow to invest, but are saddled with Conservative fiscal plans that are unworkable and a falling debt to GDP rule that discourages investment. Rachel Reeves’ priority in government should be to raise taxes to match increases in day to day spending, and to scrap the falling debt to GDP rule so that we can start investing in the public sector after a decade and a half of complete neglect.

[1] That limit, of 3% of GDP, has now become redundant as the share of public investment is planned to fall to almost 2% in five years’ time. (Public investment reached 3% of GDP three times in recent financial years: 2008/9,2009/10 and 2020/21.

[2] It would be nice to say that good fiscal rules that excluded public investment would completely avoid austerity driven cuts to that investment, but unfortunately the experience of the Coalition government suggests that is not true. As I noted many times, the structure of the primary fiscal rule first introduced by George Osborne did exclude public investment, because it had a target for the current balance (the total deficit minus net investment). As a result, there was no need for the Coalition government to cut public investment, yet that is exactly what they did, particularly in 2011 and 2012. That decision alone cost the average household thousands of pounds in lost resources.

It was this cut in public investment that really hit the UK recovery from the Global Financial Crisis recession. Quite why the Coalition government decided to cut public investment so drastically when it did nothing to meet their fiscal objectives is unclear. Did the Treasury just ask departments to cut all spending, and naturally (see above) these departments initially chose investment over current spending? Or did the Chancellor not understand his own fiscal rule?

This is why I hesitate to claim better fiscal rules might have prevented this government cutting back on public investment. When politicians have an ideological belief that everything in the public sector is inefficient and wasteful, they may ignore even the most enlightened fiscal rule.

Equally when fiscal rules become things that are changed every couple of years, as they have been since 2015, then unfortunately it also tempting for politicians that know they are nearing fiscal limits to include public investment in any target, because it is easy to cut.