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‘Fiscal Phil’ Has One Chance to Live Up to His Namesake

Ryan Bourne

For five years, the Conservatives made deficit reduction the key
plank of their economic platform.

Yet, strangely, chancellor Philip Hammond now finds himself
under pressure from much of his own party to substantially loosen
the fiscal purse strings.

Conventional wisdom says the country is weary of austerity. More
money is needed for public services. Committed Brexiteers seem to
want the chancellor to bank on some future Brexit dividend to
justify yet higher spending and tax cuts. And there are still those
who believe that anything labeled “government investment” must by
necessity be economically beneficial and worthy of higher public
borrowing.

But the economic case for higher UK government spending right
now is weak.

Keynesian economists would suggest that so-called stimulus
spending through borrowing is needed when there is lots of spare
capacity in the economy and the Bank of England has exhausted
lowering interest rates.

But with unemployment at 4.3 per cent and the Bank having
recently raised rates, the country is not in any need of some
“demand-side boost” through more public spending, even if one
believes it could at other times be beneficial.

The key issue for the UK’s growth prospects is now the outlook
for productivity — or the supply-side.

The economic case for
higher UK government spending right now is weak.

Claiming more borrowing will be “good for the economy” is really
an argument that the borrowing will boost the country’s growth
potential.

Tax cuts and commitments to eliminate tariffs after we leave the
EU could play a role here. By sharpening incentives to save,
produce and invest, or by opening up industry to the
productivity-enhancing effects of competition, cutting taxes can
raise the potential size of the economy.

However, if the path of government spending (the true burden of
government) is not adjusted downwards too, tax cuts today are in
large part tax rises in future, and blunt much of this
growth-inducing impact.

Theoretically, some spending on infrastructure investment could
enhance productivity too, if the government invested well in
high-impact schemes. But that’s a big “if”.

Actual government experience of projection selection on
infrastructure suggests it unlikely. The UK 2010 Comprehensive
Spending Review, for example, deferred, cancelled or placed under
review strategic road schemes with average benefit-cost ratios of
6.8, 3.2 and 4.2 respectively, yet persisted with HS2 with an
estimated benefit-cost ratio of 1.2.

If anything, a government concerned about long-term economic
growth might be thinking about constraining spending further. With
the tax burden already set to hit the highest level as a proportion
of GDP since Harold Wilson was Prime Minister, cutting spending
would leave more resources in the private economy, and create space
for future cuts to marginal tax rates that will be good for
growth.

The case for more spending restraint can be justified from a
public finance perspective too.

The UK is still running a modest deficit of around 2-3 per cent
of GDP a decade after the crisis. The government’s independent
fiscal watchdog — the Office for Budget Responsibility
— considers this deficit almost entirely structural.

As a result, the UK’s national debt is rising and is headed
towards 90 per cent of GDP, leaving the UK government finances in a
vulnerable position given the unknown risk of a potential recession
and the known headwinds of an ageing population.

The government really should be seeking to get the debt-to-GDP
sustainably on a downward path in the coming years, rather than
continually pushing off fiscal balance. Again, the implication is
tighter control of spending, not loosening it.

All this is not to suggest the chancellor should be unambitious
this week. There is plenty of scope for him to use the upcoming
Budget for pro-growth tax reform.

As the main economic ministry, the Treasury should be pressing
colleagues to overhaul Britain’s growth-suffocating land-use
planning laws. Even for a given amount of funds, Hammond could
reorient spending to achieve a bigger economic return.

But calls for the chancellor to open the spending taps again are
deeply irresponsible.

Those who supported Brexit should be honest enough to recognise
that it comes with significant uncertainties in the near term.

To make it a success requires long-term economic liberalisation
with the newly repatriated powers over trade, regulation, and
public money. But that liberalisation requires actually doing the
hard work of regulatory reform, gaining public acceptance for freer
trade, and limiting the size of the state to enable low taxes.

All this could enhance growth in future and provide more
resources for public services. But to simply tell the chancellor to
be more optimistic about Brexit and use that as justification for
more public spending is to put the cart before the horse. The case
for fiscal restraint is as strong today as ever.

Ryan Bourne occupies the R. Evan Scharf Chair in the Public Understanding of Economics at the Cato Institute in Washington DC.