Why do fiscal rules matter?

Fiscal rules

We have heard quite a lot in this election, particularly from Labour about the importance of sticking to clear fiscal rules.

But what are fiscal rules? Why do they matter? And are there any issues with them that that should particularly concern women?

Fiscal rules are rules are adopted by governments to try to signal to financial markets that they will manage government borrowing in a sustainable way.  When Liz Truss abandoned fiscal rules, and planned large unfunded tax cuts, the cost of government borrowing unexpectedly and rapidly went up, feeding through to rises in mortgage rates.

Governments borrow for a number of good reasons, for example to stimulate the economy and to invest in much needed public services. Financial institutions like pension funds are keen to lend to governments if they believe that government borrowing will be invested in productive ways.  The idea behind a fiscal rule is to create the expectation that the government will limit the total amount of borrowing and thus  avoid an unexpected rise in interest rates, destabilising the economy.

Although these rules are set by government, or those wishing to be in government, themselves, they are in practice often not kept. When particular rules become inconvenient, they are frequently changed (seven times since 2010). They are often also used as a political tool to distinguish a party from, and sometimes to trap, its opposition.

Like so much of what is talked about as the economy, fiscal rules are only about what’s counted in money terms, not about the contributions of unpaid care on which that monetary economy depends.

When fiscal rules are adhered to, it is often therefore at expense of what is not counted; restricting public borrowing leads to restrictions on government spending that tend to increase women’s unpaid work and reduce well-being. This has been the typical result of structural adjustment policies, similar to fiscal rules, imposed by the IMF on many low- and middle-income countries. Another example of such a false economy is restricting spending on anti-poverty measures, on education, on health or on climate change so as not to “burden future generations with debt”. But what is likely to be their greater burden?

So do we want fiscal rules?

Even if we want to constrain government borrowing, rigid rules may not be the best way to do so, because governments may stick to the letter of the rules rather than the substance behind them, or they may change the rules when they are inconvenient.

Rather than rules, might a different form of external evaluation be better? For example, NEF has suggested that a new fiscal council of experts be set up to recommend for each budget an acceptable range of borrowing, using the latest evidence. Of course then the issue shifts to such a committee’s terms of reference and the economic models they use – but in theory such a council could take account of a far wider range of issues, including impacts beyond the monetary economy.

And do we have the right rules?

Both the Conservatives and Labour have rules on:

1. The deficit, the amount by which annual spending is allowed to rise over revenue, thus requiring government borrowing:
   1. The Conservative’s rule is about the future, that in five years’ time net government borrowing will not exceed 3 percent of GDP,
   2. while Labour’s simply says it will move the current budget into balance, so that day-to-day costs are met by revenues.
2. Debt: the stock of accumulated outstanding borrowing, usually measured as a proportion of GDP. Here both parties have the same rule that they will run policy so that debt is projected to be falling as a proportion of GDP in five years’ time.

The obvious criticism of rules that are about future projections is that they can easily be gamed and are then unenforceable. It’s the Office of Budget Responsibility (OBR) that is charged with assessing whether fiscal rules are being met. All a government needs to do to meet the debt rule is to announce plans that when fed into the OBR’s economic model generates a prediction that debt will be falling in five years’ time. The government does not then need to carry out those plans.

Plans change all the time, as they should in order to react to changed circumstances. But it is better that current intentions be honestly set out, rather than gamed to meet an arbitrary target.

Labour says that by limiting just day-to-day spending its deficit rule is designed to end “the short-termist approach that disregards the importance of public investment”. This sounds sensible, but it depends on what is counted as investment. Labour contrasts investment with “day- to-day spending”.

But this is a false distinction because day-to-day spending can be an investment too; as WBG has often pointed out, spending on teachers, medical and care workers, even though it is recurrent, is an investment in the sense that it leads to better future.

Whether to make such investment should be decided like other forms of investment on the basis of whether its future benefits outweigh its current costs, not on whether it breaks arbitrary rules based on a badly defined notion of investment (and one that tends to include more of what men are typically employed to do than women).

And with respect to the debt rule, there may be issues about whether borrowing in the future will be sustainable, but fixing a point in time at which the debt to GDP ratio must fall is completely arbitrary and bringing it down over a longer period could make more sense.

More fundamentally, the wealth of a nation is not measured by its bank balance alone, but a whole range of assets including the skills, health and abilities of its population, and lenders know this.

To pay attention to the level of monetary debt alone not only leads to governments selling off national assets, it also leads to false economies in which opportunities for worthwhile investment in public services and economic stimulus are rejected unnecessarily.

As many commentators have noted, the debt rule itself may be the biggest obstacle in the way of generating a healthy economy, one which could help pay down debt at the same time as making much-needed investment in public services ¹ .