Time to change the rules of the fiscal game
Tuesday 01 October 1996
There are nearly 200 countries who have sent finance ministers to Washington for the annual meetings of the International Monetary Fund and World Bank. Only a handful (on a quick tally, fewer than 10) ran a budget surplus last year. The most important single thing that finance ministers do is to set the appropriate balance between taxation and public spending. By their own standards, virtually all fail.
When people do the opposite of what they say you can call them hypocrites. But that is a touch unfair. What is wrong is surely not so much human failure, though there's enough of that, but system failure. Something is very wrong with the way that tax and spending policies are determined throughout the developed world. It is an issue of enormous importance and if you want to choose a time when it has come to a head, this is the moment.
In the past few days there have been budgets, proposed or agreed, in four of the group of seven countries: the US, Germany, France and Italy. All had deficits, but all produced budgets which, in theory at least, cut those deficits.
Fiscal "responsibility" is the mood of the hour. These cuts are taking place for different reasons. In the US, a Republican congress, though one rather cowed by President Clinton's poll lead, has a deal which a leading Republican, Bob Livingstone, called a downsizing of government. "For the first time in modern history, we have reversed the course of government. We have begun downsizing," he said.
The three European countries have all cut their deficits to try to meet the Maastricht requirements, although not very credibly in the case of France and Italy. As for the other group, expect quite sharp tightening in Japan next year and, to judge by Kenneth Clarke's comments in Washington, a respectable further cut in the UK deficit come November.
So everyone's tightening. If you want to see a parallel, think about the mood of monetary policy in the early 1980s. Everyone agreed that something had to be done about the inflationary explosion of the 1970s and gradually, painfully, order was restored. Through the 1980s a set of guidelines was established that countries could use to maintain monetary discipline: money supplied targets; inflation targets; greater independence for central banks, and so on. Now the same is happening to fiscal policy.
What are these rules? The learning process has only just begun. The IMF has just set up a working party to look at the usefulness of various types of fiscal rules but this has yet to report. Still you can see some of the ideas that are around.
The place to start is decent and honest public accounts. Budgets are still drawn up on a year-by-year basis with maybe some projection for the next three or four years, projections which frequently turn out to be over-optimistic. Capital spending and current spending are frequently confused, and off-balance sheet liabilities concealed or ignored. Changes are being made to try to improve this in a number of countries, the UK included. But the fact remains that countries are run with a set of accounts that would disgrace a medium-sized commercial company, let alone a multinational.
Two changes in particular are needed. One is to have figures for unfunded liabilities: things to which a government is committed but which do not appear in current spending. These would include future pension liabilities. The other is to have multi-year budgets so that people can see the long- term consequences of decisions that are taken now.
Once there are decent accounts you can start to think of rules. These could be self-imposed on a country-by-country basis rather in the way that Gordon Brown has proposed some rules for the future Labour chancellor. Or they could be imposed by some external bodies like the European Union.
The EU is now debating the form that discipline might take on member governments that ran excessive fiscal deficits post-European Monetary Union. But both these ideas are unsatisfactory. There's nothing stopping a government breaking its own rules. And if the Maastricht convergence criteria are unpopular, think of the idea of European Union fines for a country that happened to break the diktat of the EU bureaucrats. But something has to be done.
In the case of monetary policy what has happened is that, to some extent, decision-making has been taken away from politicians. It's been passed to more-or-less independent central banks and, in practice, also to the world's financial markets.
I suspect that the same sort of process will take place over the next 20 years or so with fiscal policy.
Countries might establish some kind of independent body which would oversee the budgetary process. Other bodies might look at segregating social security funds so that these funds were free from political interference. It would not be possible for a government to raid people's savings to deliver tax cuts, even though those savings were merely part of a general social security contributions budget.
The markets will help too, for the more that responsible fiscal policy becomes the fashion, the more the markets will punish governments that run large deficits by whacking up long-term interest rates. The IMF may, at the margin, also help by sketching some kind of good governance practice.
But maybe the biggest change has to be in social attitudes about the proper extent and role for elected government.
We will come to think of government as not having the right to run large deficits: this is something which ought not to be part of the political process, just as we regard politicians now as not having the right to interfere with the judicial process. Wise politicians will recognise this and respect it.
Evidence that such a sea-change has begun? It is thin, I admit. But we, and I mean the whole developed world, not just the UK, can't go on as we are.
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