Debt target is not optional15 October 2012
Should we be relaxed if George Osborne dumps his government debt target in his Autumn Statement on December 5? The target is to “place public sector net debt on a downward path from 2014-15” — in other words, to have government debt falling by the end of this Parliament.
The motivation is to add credibility to the Government’s fiscal consolidation plan. The Chancellor’s problem is that growth is underperforming the levels forecast in 2010, when the target was established. It would suit the Chancellor to abolish (or radically change) the target now rather than miss it in an election year.
Two weeks ago Sir Mervyn King said that it would be “acceptable” to miss the debt target if the world economy was growing “more slowly”. Bondholders seem more nervous: a survey by Bloomberg found that only ten of the sixteen leading bond investors that it contacted would keep buying gilts if the target was missed. A quick review of the outlook for UK public debt gives even more pause for thought.
The average annual net debt was 36 per cent of GDP in the 1990s and 2000s. In this decade it will rise to 67 per cent, according to the Office for Budget Responsibility, and in the following two decades stay over 60 per cent. By the 2040s it will be 75 per cent and for the 2050s over 90 per cent.
In other words, we have enjoyed low public debt for 20 years. Now Britain’s welfare state is at a turning point. Absent policy change, its commitments to health and pensions spending will lift net debt to unprecedented levels. It is a Welfare State 2.0, which will create new pressure for higher taxes and so greater risks to growth. Given this, a debt target looks like the most important policy tool in the Chancellor’s locker, not an optional extra.
The experience of other countries is also relevant. Since its fiscal crisis in the early 1990s, Sweden has reduced its public debt from a peak of 78 per cent to 34 per cent this year (and falling to 26 per cent in 2014). In 2000, the government introduced a rule by which it has to achieve a surplus of 1 per cent of GDP over the business cycle. The crisis has had a lasting, beneficial effect because governments of all colours have resisted the temptation to overspend, either in good times or bad. As the OECD has said: “A well-defined national fiscal policy framework and a strong political commitment had allowed the country to maintain surpluses during the pre-crisis years.”
That was a challenge that the UK signally failed. Further, while the Government cannot invent immediate economic growth, it should promote productivity in the 25 per cent of the economy for which it is directly responsible. Ministers have cut budgets in services such as policing and local government and are seeing positive change as a result. The biggest public services — health and schooling — have been protected from cuts (along with pensions, the biggest budget of all) and have made little, if any, progress on efficiency.
Some public service leaders are doing wonders to change their services and would do so in any financial environment. Most doubt the Government’s commitment to reduce the deficit and certainly expect big increases in their budgets to resume when growth returns.
A firm commitment to the debt target would send a clear signal to the public sector that it is, indeed, different this time.
It might be objected that further fiscal tightening would undermine growth in the short term — but, as Mario Draghi said this year, there is no alternative to fiscal consolidation, because the levels of debt-to-GDP in many countries are “excessive”. Fiscal consolidation will be “contractionary” in the short term but will be “succeeded by long-term sustainable growth” if governments promote structural reforms at the same time. That should include public sector reform.
The debt target has particular importance because the Government’s other targets have little teeth. The inflation target has been missed for nearly all of the period since the financial crisis began. The “fiscal mandate” to eliminate the annual deficit on the public finances (as distinct to the overall debt) has already allowed the Chancellor to push back the final year of consolidation from 2015 to 2017.
It is one thing to adjust a debt target because a coherent public spending and efficiency policy has been blown temporarily off course by unexpected events. It is another to dump it in the absence of such a policy and with no sign from the party conference season that one is on the way.
There is little point in having fiscal rules if you don’t plan to meet them.
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