The Treasury’s fiscal principles – the golden rule and the sustainable investment rule – have failed for reasons similar to those that explain the failure of targets in other areas of the public sector.
In 1998, Gordon Brown as chancellor of the exchequer, laid out a long-term framework for public finances, based on the “golden rule” and the “sustainable investment rule”. This framework has failed. The rules have failed in the unimportant sense that it has not proved possible to comply with them. But the framework has failed in the much more fundamental sense that it has not provided a prudent basis for the management of public finances.
The source of the failure is familiar to everyone who has seen the effect of targets in other areas of the public sector (or private sector). Performance in any but the simplest tasks has many dimensions. Focusing on a small number of these dimensions as targets directs attention on these at the expense of others of equal importance. The difficulty is compounded when there is a shared interest on the part of target setter and target recipient in asserting that the goal has been met. And here the Treasury sets the target for itself.
The story of the Soviet factory that achieved a quota based on weight of output by manufacturing a single gigantic nail is no doubt apocryphal. But the story that ambulance crews that were set a target of meeting emergency calls within eight minutes met a large proportion of calls in seven minutes and 50 seconds is true. We do not know how far figures were doctored or the workload prioritised to enable the target to be met. All we know is that the reported statistics ceased to give useful information.
The concept of the golden rule – that taxes and current spending should match over an economic cycle – is a good one. A balanced budget on a year-by-year basis fails to allow for the tendency of expenditure and revenues to rise and fall with the economic cycle, and would encourage governments to stimulate booms and aggravate recessions.
But the rule has been applied not to offset cyclical fluctuations, but to enforce a period of famine followed by one of feast. Mr Brown’s deserved reputation for prudence is the result of tight expenditure controls in his early years as chancellor. But after 2000 the spending taps were turned on, especially in health and education. Expenditure outstripped revenues but the surpluses “banked” in the late 1990s were used to offset these deficits.
When these ran out, the Treasury stretched its definitions to assert that, despite appearances, the golden rule had been fulfilled. If you are making claims for the quality of your shooting, such claims are more convincing if the goalposts remain where they were when you kicked the ball than if they are subsequently moved to where the ball went. This is true even if they should have been placed in the new position in the first place. These manoeuvres have been sufficient to discredit the golden rule in the eyes of many commentators. But the Treasury’s disingenuous self-congratulation is not the main issue.
That issue is that, whether or not the golden rule targets have been met in a formal sense, the substantive objective has not been achieved. Another way of looking at the issue is to examine the structural deficit – an estimate of what the budget position would have been, on average, if the economy were operating neither above nor below its long-term capacity. Since the millennium, that structural deficit has increased by about 1 per cent: 2 per cent of gross domestic product. A deterioration in the underlying position of that size implies that tax increases of perhaps £20bn ($40bn, €25bn) are needed to leave a future chancellor reasonably confident that he could fulfil the golden rule. That is why the public finances are today badly placed to withstand the effects of recession.
The speeding ambulance men and the heroic metalworkers of the Soviet Union would recognise the problem. The effect of the target is to focus attention on the target rather than its purpose. The target is met; the underlying objective remains elusive.
A balanced scorecard that recognises the multiple dimensions of performance and a monitoring scheme that is flexible yet objective are needed. In subsequent columns, I will return to how economic management could achieve this and the implications for economic policy.