New Labour’s fiscal rules: ‘Prudence with a purpose’ … and cooking the books
Fiscal rules are political artefacts and social constructs whose introduction and operation need to be understood in their appropriate ideational context. The incoming New Labour Government’s move towards technocratic economic governance in 1997 was driven primarily by a yearning for greater economic credibility. Recalling Burnham (1999, 2001) and Streeck (2017), their economic strategists were convinced that independent bodies overseeing monetary and fiscal policy rules would bolster financial market credibility. Labour’s approach in some ways harked back to the public sector borrowing requirement targets used to frame budgetary discussions in the 1970s (see Tomlinson 2017, pp. 64–67). New Labour’s ‘stability through constrained discretion’ (Balls 1998; Balls and O’Donnell 2002) strategy involved establishing a track record on monetary and fiscal stability, within a ‘sound’ medium-term framework constraining economic policy.
Bank of England independence was the lynchpin. Allied to this was building fiscal credibility by sticking to pledged Conservative spending limits (that leading Tories subsequently admitted they would have breached), and introducing fiscal rules. Nudging in the same technocratic direction as monetary policy, there were efforts to counter suspicions of political manipulation of the fiscal stance presentation. As Lord O’Donnell, then Permanent Secretary to the Treasury recalls, there was talk of establishing a ‘fiscal policy committee that might derive some parameters’ for ‘policing the rules’. Stopping short of that, the National Audit Office (NAO) were tasked to ‘audit various assumptions. To be honest, the NAO were not very well equipped to be doing that job.’Footnote 13 The NAO’s remit was limited to assessing Treasury assumptions, not evaluating whether fiscal rules were met, nor adjudicating on fiscal policy priorities. Imperfection of this oversight mechanism notwithstanding the move was tacit recognition of the significance of the ‘politics of economic method’.
The wider global context of New Labour’s political economy was later termed the ‘Great Complacence’ (Engelen et al. 2011). The so-called NICE decade of non-inflationary continuous expansion for advanced economies fed Chancellor Brown’s hubristic claims of an end to boom and bust. Central bankers, politicians, and some leading economists believed the secrets of enduring prosperity had been unlocked, the mysteries of depression prevention solved, provided fiscal prudence was assured.
Two fiscal rules, adopted by the Chancellor in the 1998 Finance Act, anchored the fiscal framework to assure credibility. They took the form of broad fiscal principles, subject to some interpretive flexibility in their application, rather than numerically specified targets. First, the ‘Golden Rule’ demonstrated fiscal prudence whilst simultaneously addressing historical UK under-investment. It specified that, over the cycle, the government would borrow only to invest, not fund current spending (Treasury 1998). The second, the sustainable investment rule, pledged that public sector net debt (PSND, i.e. the accumulated borrowings of government) would be held at ‘stable and prudent levels’ (Treasury 1998; Balls and O’Donnell 2002, p. 167).
The relevant historical context here was the dramatic drop in UK public sector investment since the 1970s. This new fiscal regime was explicitly ‘designed to remove the bias against capital spending’ within the UK’s public expenditure framework (Balls and O’Donnell 2002, pp. 160–161). Reducing capital investment was politically easier, even where the economic rationale may be weak. The Golden Rule therefore incorporated a capital/current spending distinction new to the UK fiscal regime. It thus inscribed a critique of successive past Conservative governments’ systemic under-investment.
Turning to the politics of economic ideas behind New Labour’s rules, Berry and Lavery’s depoliticisation-inspired account sees New Labour macroeconomic thinking as not ‘based on a grand economic theory’, be it monetarist or Keynesian. Rather, their nuanced interpretation characterises Labour’s self-imposed rules as ‘a rather artificial demonstration of New Labour’s commitment to a neoclassical paradigm’ (2017, pp. 258, 259). Understated in this view is that the UK’s fiscal rules architects saw them as embodying the ‘new growth agenda’ and the ‘pioneering work of Paul Romer’ (Balls and O’Donnell 2002, pp. 29–30; Balls 1998).Footnote 14 Thus, an important ideational element of New Labour’s rules regime was ‘post-neoclassical endogenous growth theory’ (Romer 1986; Crafts 1996).
‘New’ growth theory challenges a priori neoclassical assumptions of diminishing investment returns, anticipating instead constant or increasing returns (see Crafts 2018). More broadly, it foregrounds ‘a much more sophisticated role for governments’ in areas including competition policy, corporate governance, regional development and education and training (Balls 1998, p. 116). Unlike the neoclassical view, exogenous technological change may not be the main growth catalyst. ‘New’ growth theorists identify a wide-ranging government role ‘encouraging investment in the broadest sense: not just in machines, but in technology and innovation, skills and infrastructure’ (Balls and O’Donnell 2002, pp. 29–30). Thus, Labour’s technocratic fiscal rules regime was informed by particular principles of political economy, a distinctive role for the state, and a critique of Conservative economic management priorities.
These fiscal and monetary rules were well received by economic commentators. New Labour accrued credibility and confidence, enabling ‘iron’ Chancellor Brown to exploit the ‘constrained discretion’ within their framework. Illustrating the pay-offs of this discursive construction of economic rectitude, the 2000 budget ramped up investment and spending on the NHS and other priorities. Upon winning a second term, Brown increased spending further, with no increase in borrowing costs (Clift and Tomlinson 2007).
The fiscal regime’s broad principles offered yardsticks to judge the Chancellor’s prudence. Yet flexibility within the self-imposed rules framework could be exploited politically. Brown’s apparent demonstration of economic rectitude entailed both a politics of numbers and a politics of economic method. To maintain the appearance of fiscal probity whilst increasing spending, in 2005, Brown ‘re-interpreted’ his own fiscal rules, demonstrating the discretion, judgement and interpretation inherent within any economic rules regime (see Batini and Haldane 1999, p. 159; Best 2019, Best 2021).Footnote 15
The uncertainty that constructivist political economy highlights is particularly pronounced regarding the economic cycle’s timing. Exploiting the cycle’s inherent uncertainty and contestability, Brown retrospectively altered the UK cycle’s start from 1997 to 1999 (Treasury 2005; NAO 2005; Berry and Lavery 2017, p. 259). This indicates the significance and policy salience of the politics of economic method, which in turn draws attention to the flexibility and interpretive leeway inherent within fiscal rules regimes.
This reinterpretation afforded latitude to maintain spending whilst still ‘meeting’ Brown’s Golden Rule over the (redefined) cycle. The Treasury’s manoeuvre drew adverse comment from the Treasury Select Committee and the Institute for Fiscal Studies amongst other expert observers. Alternative UK cycle assessment techniques, such as statistical filters, showed the Golden Rule breached substantially, and a cycle running from 2003 to 2010 (not 1999–2007) (IFS 2007, p. 2). As Lord O’Donnell, former Permanent Secretary to the Treasury and Cabinet Secretary, notes, gauging the economic cycle is ‘a very approximate art. And when you’ve got those approximations, you are going to have political desire. If we chose that date rather than that date, that generates more revenue for us to use … the bias for the politicians is towards taking certain interpretations that implies things are better.’Footnote 16 Thus fiscal rules do not end discretionary policy-making, nor exert the iron fiscal discipline often mooted as their rationale.
Illustrating the importance of both discursively framing the fiscal discussion and the politics of method, Chancellor Brown exploited uncertainty about the UK’s trend growth rate, altering it in the 2006 pre-budget report from 2.5 to 2.75%. Trend growth rate assumptions are key to the fiscal forecasting necessary for gauging the fiscal stance and fiscal rules. Whilst not directly altering the forecast (2.5% was used for public finances projections), Brown’s growth rate change professed ‘prudence’ by retaining prior 2.5% projections as a ‘cautious’ case. Within months, even this ‘cautious’ assessment looked distinctly over-optimistic (Treasury 2006, p. 191; Treasury Select Committee 2007, pp. 14–15, 17; IFS 2007, p. 2).
There is a pathology of Chancellors overestimating their economic management skills, presuming to buck historical growth trends. As former Permanent Secretary to the Treasury Lord Macpherson recalls ‘both following the Lawson Boom of the 1980s and the long period of growth through the 1990s and early 2000s, there had been a tendency to believe that cyclical improvements constituted structural improvements.’Footnote 17 Septuagenarian Professor Nickell notes ‘governments have been trying to improve the British economy’s growth rate for as long as I’ve been alive, and we’re not there’. Hence he remains ‘very sceptical about claims that the government are going to raise the British economy’s trend growth rate.’Footnote 18 Ironically, the shift towards credibility-bolstering technocratic fiscal rules makes these questionable reassessments more consequential in framing the fiscal stance and assessing fiscal sustainability.
New Labour’s authorship of their fiscal rules afforded flexibility and discretion in other ways, too. Well-crafted rules regimes can in theory withstand economic shocks, but the GFC’s momentous scale placed UK fiscal rules under enormous strain. Reduced tax revenues due to depressed economic activity, and the costs of rescue and counter-cyclical measures saw debt rise to 79% of GDP, and the deficit to 12%. New Labour effectively suspended its fiscal regime, introducing a ‘temporary operating rule’, pledging ‘to set policies to improve the cyclically adjusted current budget each year’, targeting balance and getting debt falling as a proportion of GDP ‘once the shocks have worked their way through the economy in full’ (Treasury 2009, pp. 19, 27, 31, 35–38). This was but the first of many UK fiscal rule amendments, illustrating the latitude for governments enjoying credibility to (re-)construct fiscal yardsticks by which they are judged.
New Labour’s institutional innovations reflected an ideational context where their overriding priority was restoring the electorate’s trust in Labour’s economic management capabilities. Their discursive construction of economic credibility via ‘stability through constrained discretion’ (Balls 1998; Balls and O’Donnell 2002) in time afforded government scope to boost public spending and investment on its priorities (see Annesley and Gamble 2004; Clift and Tomlinson 2007). Brown termed this ‘prudence with a purpose’, yet ‘observance’ of fiscal rules resulted not from iron fiscal discipline, but from the politics of numbers—manipulating economic statistics. His exploitation of inherently contestable economic constructs (the economic cycle, the trend growth rate) integral to fiscal rules reveals how consequential the politics of economic method can be. Careful crafting of fiscal rules, and their oversight, contained significant wiggle room. When the GFC put the rules under strain, the government simply changed them. New Labour were not tied to the mast as tightly as their careful construction of fiscal rectitude suggested.
The Coalition and the OBR: Beating Labour with a fiscal stick … and still cooking the books
The ideational context surrounding the Conservative/Liberal Democrat coalition’s social construction of economic rectitude was a changed fiscal politics. The Conservative (re-)conversion to a hawkish, Gladstonian fiscal stance began in 2009 (Lavery 2019, pp. 111–112). Deteriorating post-crash public finances fuelled the politics of austerity, heralding 2010’s shift in UK fiscal philosophy. Lord Macpherson, then Permanent Secretary to the Treasury, recalls ‘the country needed a fiscal consolidation plan … Cameron and Osborne were particularly keen on it, so they made the plan a test of the government’s credibility … within a couple of weeks of the general election, there were £5 billion of in-year cuts for the year 2010/2011.’Footnote 19 The narrative underlying macroeconomic policy changed from Britain’s ‘crisis of growth’ to its ‘crisis of debt’, seeing high debt as mechanically damaging to growth (Hay 2013; Osborne 2011).
NCM-inspired expansionary fiscal contraction arguments (Alesina and Giavazzi 2013; Dellepiane-Avellaneda 2015) informed Coalition Government thinking. The June 2010 Budget document noted that ‘accelerated fiscal consolidation will help keep market interest rates lower for longer, supporting economic recovery’ and furthermore the government’s ‘credible deficit reduction plan’ should ‘provide businesses with the confidence they need to plan and invest, supporting the necessary recovery in business investment’ (Treasury 2010, p. 9). The Treasury highlighted ‘wider economic effects’ of fiscal consolidation, which ‘will tend to boost demand growth, could improve underlying performance of the economy, and could even be sufficiently strong to outweigh the negative effects’ (Treasury 2010, p. 19).
Once again, the politics of economic ideas fused with partisan politics within technocratic economic governance. The Conservatives critiqued Labour’s record via a fundamental reassessment of the economic orthodoxy underpinning macroeconomic policy. The new fiscal philosophy urged the nation to ‘live within its means’. Britain should ‘pay its way in the world’. Household finance analogies, which are erroneous when applied to the public finances, were trotted out to resonate with electorates uninterested in the technical intricacies of macroeconomic policy (Stanley 2014). As Best points out, regarding the social production of monetary credibility, ‘to be effective, such narratives do not necessarily have to be accurate, but they do have to be widely accepted’ (2019, p. 628). The policy corollaries of these narratives were the harsh public expenditure cuts outlined above. This changed politics of fiscal rectitude was reflected in fresh UK fiscal rules, and a new fiscal watchdog.
There were two aspects to Osborne’s critique of Labour fiscal governance. The first was that New Labour’s fiscal rules regime, predicated on over-optimistic growth forecasts, carried a deficit bias risk. Furthermore, Brown was wont to move the goalposts. Second, New Labour’s mooted fiscal profligacy had supposedly caused the 2008–2009 crash. The Golden Rule’s ‘key failing’ was it was ‘too backward looking’, supposedly allowing fiscal deterioration and profligacy on Labour’s watch (Treasury 2010, pp. 12–13). Implying a Greek-style crisis loomed, the June 2010 Budget document claimed Labour’s fiscal trajectory would ‘put the recovery at risk’ (Treasury 2010, pp. 1, 12, 14).
The Coalition’s economic analysis made bold assumptions about debt’s adverse effects on future growth, and accordingly prioritised fiscal retrenchment. Osborne articulated a new ‘fiscal mandate’, citing the 2010 G20’s focus on ‘growth friendly fiscal consolidation’ (see Blyth 2013; Clift 2018, pp. 128–130). The 2010 rules reflected this new-found emphasis through commitments to secure structural balance by 2015/2016. The debt target pledged falling year-on-year changes in the ratio of PSND to GDP by 2015–2016, a year earlier than Labour had planned. Credibility for this mandate would be enhanced by the newly created independent OBR. The Conservatives had set up a ‘shadow’ OBR, with Sir Alan Budd at its head, in opposition in 2009. This became the interim OBR, still headed by Budd, established in summer 2010 in anticipation of its founding legislation, the Budget Responsibility and National Audit Act 2011. The OBR’s creation was a prime example of multiple dimensions of politics in fiscal rules. Osborne presented the OBR as an incarnation of his central critique of Labour—in terms of the politics of numbers (Brown’s cooking the books), the politics of economic method (moving the goalposts of the economic cycle), and the politics of economic ideas (‘Labour’s debt crisis’). The first two criticisms were well-founded, whilst the third was specious. As Budd’s replacement as OBR Director, Robert Chote put it bluntly, ‘no sane person would argue that poor management of the public finances directly caused the crisis in 2008–09.’Footnote 20 The Conservatives combined and conflated these, construing them as Labour’s economic management problems that the OBR was created to solve. Its creation by the Conservatives in opposition, and the OBR’s imbrication in this partisan fiscal tussle, gives the lie to technocratic governance as apolitical.
The OBR has received limited attention to date in the political economy literature. Berry and Lavery, focusing on depoliticisation and repoliticisation dynamics, analyse its establishment and operation in terms of a ‘profoundly political agenda that underpins institutional reform’. Their nuanced and intricate argument portrays the OBR as ‘the institutionalisation of austerity’ (Berry and Lavery 2017, pp. 256, 259). Others connect the OBR and austerity in more straightforward fashion (see, e.g. Pettifor 2017). Underlining the association between the OBR and austerity is understandable. After all, expansionary austerity arguments and accusations of fiscal irresponsibility dominated Coalition fiscal consolidation discourse at the time of its inception. Similar ideas framed Osborne’s new fiscal rules. As a fiscal watchdog, the OBR’s core remit is overseeing observance of fiscal rules, assuring sustainable public finances. Prioritising fiscal prudence and highlighting fiscal risks therefore comes with the territory.
Yet drawing too a direct link between the OBR and austerity, as Pettifor does (2017), misreads their remit, and their intellectual autonomy. It also underestimates the scope for fiscal rules regimes to change. The OBR exists to adjudicate on the rules written into the Charter of Budget Responsibility. Yet those can and do change (see below), placing greater or lesser emphasis on fiscal consolidation by altering the desired trajectory for deficit and debt. Under each iteration of UK fiscal rules, expansionary fiscal policy would be condoned where the OBR identifies a large output gap. In the realms of the politics of economic method, and the political economic ideas informing OBR modelling and forecasting, their baseline assumptions have always included positive fiscal multipliers, albeit moderate at around 0.5–0.7. An austerity-centric view sees fiscal multipliers as absent, or even negative.
Early on, the OBR debunked austerian claims that Labour’s fiscal stance had been profligate or had caused the crisis. Their evaluation of June 2010’s ‘emergency’ budget noted a stable structural deficit consistently around 1% of GDP between 2002 and 2007, standing at 0.4% GDP in 2006–2007, and 0.6% of GDP in 2007–2008 (OBR 2010, p. 91, Chart C6, 104). Their public sector net borrowing (PSNB) fan chart showed a relatively flat line between 2002 and 2007, close to 2% of GDP (OBR 2010, p. 86, Chart C4). When Cameron claimed in March 2013 that the OBR had made it ‘absolutely clear’ that austerity policies were not responsible for depressed growth, Chote rebuked Cameron. In the OBR’s view, consolidation was responsible for roughly 1.4% of lower UK growth between 2011 and 2012 (Chote 2013). Thus, the OBR’s relationship with the politics of austerity is far from straightforward.
The OBR has autonomy to use whatever models and assumptions it chooses in assessing the public finances.Footnote 21 For example, by the mid-to-late 2010s the OBR were affording increasing credence to secular stagnation (Gordon 2016; Summers 2014) and hysteresis accounts of advanced economies (OBR 2017b, p. 35),Footnote 22 albeit Andy King noted ‘we're not full secular stagnation in that we do think [the economy] will recover.’Footnote 23 These are scarcely austerity-centric views, one policy corollary of secular stagnation being more activist fiscal policy (OBR 2017c, pp. 47–48). As OBR Chief Economist Charles Bean put it, ‘I'm very amenable to more active use of fiscal policy. It's now very cheap for the government to borrow, so surely this is a time to be doing lots of borrowing and investment in infrastructure … you've got scope to run quite big deficits if you have a framework which is credible for the longer term.’Footnote 24 Commentary on macroeconomic responses to COVID further demonstrated the OBR’s willingness to endorse extraordinary levels of fiscal activism (OBR 2020a, b).
Prior to the OBR’s establishment, many UK Chancellors had engaged in ‘politically motivated wishful thinking’ (OECD 2020, p. 13), using over-optimistic growth forecasts to assume away tough choices. As Lord Macpherson puts it, ‘it was the Chancellor’s forecast, so if the Chancellor wanted to believe that the trend rate of growth had improved, it was possible to reflect that in the forecast.’Footnote 25 Osborne outlined the OBR’s rationale was to “remove [from politicians] the temptation to fiddle the figures by giving up control over the economic and fiscal forecast” (Treasury 2010). Since 2010, the Treasury has been reliant on the OBR for the official forecast. As Chote puts it, ‘what is unusual is not that we do a forecast, but that the government no longer does one.’Footnote 26
A striking feature of Coalition and Conservative fiscal rules is their frequent alteration. The debt target moved back to 2016–2017 in December 2014. The fiscal mandate was recodified, the Charter rewritten. The high-water mark of Osborne’s hawkish fiscal approach, adopted for the 2015 election, required a surplus on headline PSNB by 2019–2020. This rules rewrite also introduced more stringent requirements for annual falls in the ratio of public debt to GDP from 2015 to 2016 onwards. Austerian targets for structural surpluses in normal times and faster debt reduction were politically totemic, but as measures blind to the cycle they were potentially economically harmful (Portes 2015).
The OBR continually expressed scepticism about UK government chances of achieving structural surplus, but the target nevertheless performed its role within partisan fiscal politics. It codified supposedly superior Conservative fiscal rectitude, an impression Labour find perennially hard to overturn. This fiscal politics ‘works’ even if the economic rationale for structural surpluses is weak (see also Best 2019). It even works if, as the OBR envisaged by November 2016, the headline surplus mandate would be missed by a wide margin (OBR 2016, pp. 199–200).
The changed administration following Brexit saw the Charter altered again in October 2016. The May government was not defined by a commitment to austerity, and fiscal targets were relaxed accordingly. Less rigorous rules reflected these changing principles of political economy, more favourable to state activism and intervention. The revised fiscal objective pledged to ‘return the public finances to balance at the earliest possible date in the next parliament’, anticipated to run 2020–2025. This less exacting ‘fiscal mandate’ targeted getting the structural deficit (cyclically adjusted PSNB) below 2% of GDP by 2020–2021, and PSND to fall as a proportion of GDP by 2020–2021.
Turning to the politics of numbers, for all Osborne’s critique of Labour book-cooking, Conservative Chancellors were unrelenting in their fiscal manipulations. The OBR consistently noted the ‘scorecard artistry’ of Osborne’s Treasury. Spending commitments were manoeuvred into following years (whilst preventing departments from bringing spending forward) in order that, within specified forecast periods, fiscal targets were notionally hit. For example, in 2013 the Chancellor delayed World Bank payments until the following financial year, and allowed departments to underspend more than normal. This massaged down departmental spending projections, the unusual scale of the underspends being remarked upon wryly by the OBR (OBR 2013a, pp. 93, 128–132). This creative accounting enabled the Chancellor to claim, consistent with earlier commitments, that the deficit was ‘just’ on a downwards trajectory (Osborne 2013). As Chote put it, ‘You can have an astonishing degree of policy fine-tuning to achieve very precise forecast outcomes even though in statistical, or fiscal, or economic terms, it matters not a hoot if a number you care about is £10.5 billion or £10.6 billion.’Footnote 27
Under Chancellor Hammond in 2017, £700m of projected spending moved from 1 year to the next, prompting this exchange with OBR Director Chote in the Treasury Select Committee:
Chair: Do you think that was done in order to show that the net debt figure did fall, as part of the targets that the Government set themselves?
Robert Chote: It is not for me to put windows into people’s souls, but it seems that might be a plausible explanation. (Treasury Select Committee 2017)
Between 2010 and 2017, UK fiscal rules evolved to become first more austerity-centric, then less so. Meanwhile, Chancellors engaged in ‘scorecard artistry’, such that impermanence and flexibility were abiding characteristics of UK technocratic economic governance. The actual conduct of policy did not betray the levels of fiscal discipline Osborne espoused. The OBR frequently noted that fiscal targets were often not on course to be met. As Lord Macpherson recalls, when the Government changed fiscal objectives, ‘the OBR took great pleasure in saying, this is what you’re doing against the revised objective. But then added in, compared to the original objective, you’re totally off track … the fact that the OBR was still commenting about the old objective was a reminder to everybody that the Government had changed the goal posts.’Footnote 28 Once again, governments were not as tightly bound to the mast of fiscal rectitude as the political economy literature often suggests.