The election campaign has only just got going, but already spending promises are coming thick and fast. By the time we get to polling day, still a month away, this could turn out to have been a very expensive election, indeed. Up to £20 billion a year of extra investment spending has been pledged by the Tories, £55 billion by Labour.
Let’s start with getting a handle on orders of magnitude. Big. Very big. Labour wants to more than double government spending on capital projects, taking capital spending by the UK government right to the top of the international league table. While the Conservative figure looks small by comparison, it would still represent a huge increase on present levels of expenditure and would bring it well above anything we have sustained over the past 40 years.
Moving on from the shock and awe at the scale — and glossing over whether Labour’s plans, in particular, are remotely deliverable within the next parliament — what does all this tell us about the parties’ attitudes to fiscal and economic management?
Sajid Javid, the chancellor, is clear about what has driven his apparent change of heart. It looks like very low interest rates are here to stay. Government debt has more than doubled as a share of national income, but falling interest rates mean that the share of national income devoted to servicing that debt has fallen. So long as economic growth remains higher than the interest rate on government debt, there may be little cause to worry about one-off increases in debt, such as that which occurred in the decade after the financial crisis.
Take that argument one step further and you can make the case for borrowing more to fund valuable infrastructure investment, particularly if one can think of a spurt of debt-financed infrastructure spending as a one-off. Whether this gives a green light to permanently maintaining a level of borrowing in which the debt-to-GDP ratio woulde climb year after year is less clear. As the Office for Budget Responsibility pointed out in its most recent fiscal risks report, while the actual debt level may not impede the medium-term economic outlook, its trajectory does matter.
The OBR also makes clear that low interest rates can play only a small role in offsetting the big fiscal challenges coming down the road from the higher spending on health, state pensions and social care that will result from an ageing population. Letting debt rise a lot now, when we know that fiscal pressures will be much greater in 20 years’ time, is riskier than it would be in a world without adverse demographics.
It also states that it is “important to emphasise the credibility and resilience of the UK’s policy framework as a factor determining the level of debt that can be safely sustained”. In explaining its decision last week to lower Britain’s credit outlook, Moody’s, the credit rating agency, said that “the capability and predictability that has traditionally distinguished the UK’s institutional framework has diminished”.
The OBR view is that “the most plausible scenario in which interest rates would significantly exceed growth rates is one in which market participants lose confidence in the institutional framework and start to expect default and/or monetisation”. If lenders lose faith in the stability of UK governance and institutions, then they may demand higher interest rates on UK government debt, or simply lend elsewhere. That is only one route through which prolonged political instability can have negative economic consequences. Politicians should take note.
So where do the parties’ policies fit in? With £20 billion of additional borrowing, as planned by the Conservatives, debt would not fall as a fraction of national income. Labour’s plans to borrow an additional £55 billion a year would put debt on a rising path. Recognising that, John McDonnell, the shadow chancellor, has said that rather than managing the debt-to-GDP ratio, he wants to target the government’s net asset position. When borrowing is used to buy stuff — be it hospitals, windmills or roads — that is worth as much or more than the cash spent, then the government’s net asset position will be unaffected or will improve.
Fair enough, up to a point. The present system of targeting a very specific measure of financial deficits and debt can lead to silly behaviour — private finance deals, selling the student loan book and the like. Focusing on the net asset position also would prove helpful to a government looking to engage in widespread nationalisations. Paying for them will increase the national debt, but, as long as they don’t become less valuable once in public hands, it seems odd to think of the public finances as having been made worse off by buying something for what it’s worth.
There are problems here, though. Defining and measuring assets in a way that is transparent and meaningful is staggeringly hard. We do have a measure of net assets, but it bears little relationship to our capacity to borrow and service debt. In fact, by far the biggest assets any government has are the capacity to tax and, once again, widespread confidence in a credible and resilient policy and institutional framework.
The bigger picture with regard to Labour’s plans is that it is planning a much bigger role for the state in the running of the economy. That’s what nationalisations mean and it’s what government spending an extra 2 per cent of national income on capital projects means. The real resources — workers, raw materials, machinery — would be diverted from the private sector to the public.
The question, then, is not so much how much all this would all cost; rather, it is how confident are we that these resources would be put to better use in public hands than in private.
Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist. We've set up a resource to help you separate election facts from election fiction. Find out more here.
This article was first published in The Times and is reproduced here with permission.