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Gordon Brown

We have to cap the national debt

Jul 15th, 2011
by David Cowan.
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On July 12th Sajid Javid MP proposed a ten minute rule bill to cap the UK’s national debt. Ironically, he is seeking to enshrine in law what Gordon Brown originally established as his two fiscal rules. First was the ‘Golden Rule’ that the government should only borrow to invest in capital investment, such as infrastructure. Second was the ‘Sustainable Development Rule’ which dictated that the national debt should not exceed 40% GDP and the budget deficit 3% GDP. Though these fiscal rules are sound in principle they were not adhered to in practice. One of the key problems was the lack of accountability; the Chancellor decided whether or not they applied and ultimately tore them up after the financial crisis. This is the problem Sajid Javid MP hopes to remedy.

Sajid Javid MP proposes capping the national debt

Politicians are by nature short termist. They think about the electoral cycle rather than the boom and bust cycle. Gordon Brown was not the exception. He spent billions of taxpayers’ money and then left it to the next government to foot the bill for his excess. At first it might seem George Osborne is reversing this situation as public spending will fall from 47.7% GDP in 2009-10 to 39.9% GDP in 2015-16, borrowing will fall from £156.4bn to £29bn, and the budget deficit will fall from 11.1% GDP to 1.5% GDP. This would make it easy for a 3% budget deficit target to be introduced and new borrowing rules to be drawn up.

However, upon closer inspection we can see that fiscal prudence isn’t being pursued in every area. In cash terms public spending will actually increase from £669.7 billion in 2009-10 to £763.8 billion in 2015-16. When inflation is taken into account the cut to public expenditure being made by George Osborne is only 3.4%, less than Barack Obama is cutting in one year. Furthermore, the budget deficit will not be eliminated by 2015. It is the ‘structural budget deficit’ which is being eliminated. In practical terms this means the national debt will only stop growing in 2015 after increasing to £1.4 trillion. Fiscal responsibility cannot stop in 2015.

Sajid Javid MP’s ‘National Debt Cap Bill’ lays a clear path beyond 2015 with the suggested 40% GDP target for the national debt by 2025. However, the official Treasury figures do not reflect the true nature of the UK’s national debt, as this TPA report and video (below) demonstrate, as they do not include ‘hidden liabilities’ such as state funded pensions, nationalised banks, Network Rail, or PFI contracts which put the real national debt at £7.9 trillion (560% GDP). That’s £300,000 for every UK household. The official figures only make up 10% of the real debt. If Sajid Javid MP’s bill does not include these hidden liabilities within the Treasury’s national debt figures then we will fail to get to grips with the situation.

One of George Osborne’s most significant innovations has been to establish the Office for Budget Responsibility to maintain honest and transparent forecasting. If the fiscal targets set out are to be maintained then the OBR has to publish hidden liabilities on the government’s balance sheet. The existing targets also need to be supplemented by an expenditure target, as we recommended in our book How to Cut Public Spending.

Of course merely passing a law capping the national debt will not actually reduce the debt in itself, just as the Bank of England’s inflation target and monthly letter to the Chancellor haven’t kept down inflation. That law can always be changed if it is felt to be necessary. It does however help to keep the state of the nation’s finances in the public debate and force politicians to think more long term when making fiscal decisions instead of pursuing short term electioneering.

Gordon Brown admits a mistake, but politicians now might be making an even bigger one

Apr 11th, 2011
by Matthew Sinclair.
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Gordon Brown has admitted that a mistake was made in the regulatory structure for financial services ahead of the crisis, principally in a failure to appreciate systemic risk.  He blamed pressures for less regulation from those concerned at the competitiveness of the City – despite the fact the problem was clearly the wrong regulation rather than just too little – and said that the same mistake was made by “just about everybody”.  Is that true?  And, if we want to avoid future crises, where could the next mistake fall?

Here are a few of the mistakes that I would say were key to the recent crisis:

  • Excessive optimism about the path of asset prices and particularly the sustainability of the boom in house prices and therefore mortgage backed securities.  Everything from bank strategies to the path of public spending were much too vulnerable to the property market getting in trouble.
  • Insufficient appreciation of systemic risk.  Regulations were too focussed on individual firms ticking boxes to show that they were treating customers fairly rather than on factors that could lead to a broader collapse.  This is the mistake that Brown acknowledges.
  • The euro.  Many of the smaller eurozone economies are completely in the tank but getting higher interest rates because they are needed by Germany.  They got in trouble because a then sluggish Germany needed lower interest rates that encouraged an asset boom when they were growing rapidly.
  • The tripartite structure of financial regulation left the Bank of England poorly prepared for its lender of last resort role in a crisis.

Only the first was really a mistake that all of the main institutional players made and was reinforced by other mistakes like the procyclical Basel regulations.  The British Bankers Association were warning that regulation was insufficiently focussed on systemic risk well before the crisis.  Lots of sceptics, then derided by the likes of the Financial Times, argued the euro would be a disaster.  David B. Smith, now Chief Economist of the 2020 Tax Commission, pointed out the weaknesses of the tripartite structure.  There is more about how we got into the financial crisis in a report we released a couple of years ago.

More important than the old mistakes, are the new ones.

Over the weekend Ed Balls set out international agreement on changes to financial regulation as one of his “tests” for the chancellor.  He argues that is necessary to protect jobs and the competitiveness of the City.  A feeling that the City is resented and a target for ever higher taxes is driving investment and employment abroad.  I don’t think reasonable regulation that is genuinely conducive to financial stability is nearly as problematic.  The real danger is in following the crowd and making common mistakes, not in standing out and trying to set a more reasonable course.

In a paper published with the Legatum Institute we looked at the dangers of the trend towards financial regulation being increasingly globalised.  There is a huge risk that everyone makes the same mistakes at the same time leading to global crises that are far more dangerous to the entire financial system, and create the risk of a collapse that drives future bailouts and recessions.  As we wrote in that paper:

“Common capital adequacy rules, while increasing transparency, also encourage homogeneity in investment strategy and undertaking of risk, leading to a high concentration of risk. That means that global regulations can be dangerous because they increase the amplitude of global credit cycles. If every country is in phase, systemic risk is higher than in situations where there are offsetting, out of phase, credit booms and busts in individual countries. The situation is akin to a monoculture, a lack of diversity makes the whole crop more vulnerable.”

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