Tax and Fiscal Policy

Hammond should ignore siren calls for more fiscal stimulus and develop a real strategy for growth

A question, readers. Who said “spending and borrowing our way out of a recession, over and above the levels that are implied by the automatic stabilisers… will not work and is not sustainable”? Clue: he’s now Chancellor of the Exchequer. Philip Hammond once believed that Keynesian demand management was a fool’s errand. Just two weeks into his job, he is now talking about more spending or tax cuts to see off post-Brexit uncertainty.

To be fair, Hammond is only echoing the clarion calls from “the usual suspects”, who demand more spending whatever the political weather. For this group of economists, running a deficit already at 4 per cent of GDP a full eight years after the crisis is no bother.

But while the prospect of a catastrophic market reaction to more short-term borrowing is small, a discretionary fiscal stimulus now would be a waste of money and fail to address the UK’s real economic challenges. It would merely leave us more indebted as we face significant fiscal headwinds in the coming decades.

Consider two potential causes of the supposed slowdown. First, it may reflect short-term uncertainty. That would dissipate when the uncertainty is removed, and the economy would rebound. If so, rather than increasing government spending, why not take steps to actually end the uncertainty? Outline the status of existing EU migrants in the UK. State Britain’s fall-back position if a bilateral deal with the EU cannot be reached. Signal a non-EU trade strategy.

Trying to counter policy uncertainty by adjusting spending instead is problematic, because the timing of new projects often does not align with the cycle of real economic activity. Most projects are not “shovel ready”, and then attempting to cut back spending when the economy recovers becomes politically difficult. That’s one reason why monetary policy, which tries to target a level of nominal income, is far more flexible in adjusting to unpredictable shocks to demand.

But what if, far from being an uncertainty effect, any slowdown is actually a sign that markets think Brexit will be bad for the productive potential of the UK? In that case, the underlying fiscal position will actually be worse and more fiscal consolidation, not less, would be appropriate in the medium term.

To prevent the need for this would require not a fiscal stimulus, but a growth strategy. That is, attempts to improve the UK’s underlying growth rate – something which is needed anyway given our dismal productivity performance. This might include: a simplified, pro-growth tax system; adoption of unilateral free trade; planning reform; more airport capacity; cheaper energy; and steps to reform the state pension and healthcare funding given an ageing population. In other words, not temporary government spending.

The fiscal stimulus crowd’s response to this is to state that infrastructure spending can provide the best of both worlds: we can boost demand now, and improve the productivity of the UK with better transport connections and more efficient energy in future. Which is great in theory: if only governments always selected projects with high returns, rather than playing politics, we would end up with lots of small road improvement schemes rather than white elephants such as HS2; cheap energy rather than expensive renewables. We would also not end up with the government blocking private sector investment in genuinely worthwhile projects, such as airport expansion.

In fact, due to the political incentives or lack of market disciplines, the link between public spending on investment and economic growth tends to be weak. The US, which ranks worse than us on the quality of its infrastructure, almost always grows more robustly. Japan spent tonnes of public money on big projects, and ended up with bridges to nowhere. Spain, likewise, was left with empty airports.

Rather than opening the taps further, the chancellor’s fiscal strategy should be to continue with the broad spending plans, but allow automatic stabilisers to operate if the economy does slow and to re-orientate any spending within the existing envelope given new post-Brexit priorities. The aim must still be to get the public debt-to-GDP ratio back on a downward path via running surpluses, given the strong upward pressures on debt coming from demographic trends and the already high levels of peacetime debt. Fiscal sanity and a pro-growth agenda is what is really needed, and always has been.

Ryan Bourne is the IEA’s Head of Public Policy, and Director of the Paragon Initiative. This article was first published by City AM

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.

2 thoughts on “Hammond should ignore siren calls for more fiscal stimulus and develop a real strategy for growth”

  1. Posted 31/07/2016 at 14:25 | Permalink

    An eye-catching headline which necessitated an immediate read. A very lucid report damning a poorly researched Oxfam letter backed by 100s of economists ; that offshore tax havens faciliate dispersal of investment funds to developing nations, thus bypassing the hugely complex mishmash of the international tax system makes complete sense. Something that never occurred to me.

  2. Posted 01/08/2016 at 07:45 | Permalink

    It’s not the fiscal position that warrants concern. Instead it’s the external deficit, which would be made worse by adopting unilateral free trade,(as well as undermining the UK’s negotiating power in forthcoming trade deals with the rest of the world).

    It seems inconsistent to frown on one type of deficit (the government’s) and then to simultaneously encourage profligacy in respect of the other deficit, namely the current account deficit (which has to be financed either by borrowing from foreigners or by flogging our assets to them).

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