06 April 2007
One of Gordon Brown's first moves as chancellor was to outsource responsibility for interest rates to the Monetary Policy Committee. So should he go further and create an independent body to oversee his own fiscal rules, ask Ann Rossiter and Stephen Evans
The chancellor closed the 2007 Budget with a flourish, cutting the basic rate of income tax to 20%. But this was just the twist in the tale. Gordon Brown used much of his final performance to look back a decade to the economy he inherited and to set out his claim to be one of the country's great chancellors.
Whether you accept this depends on if you believe that Brown's fiscal discipline is the key factor underpinning the strength of Britain's finances. He stated the case for this view with typical robustness, arguing that his prudence had brought an end to 'boom and bust', with a single economic cycle in which he has not only balanced spending and revenues, thereby meeting his 'golden rule', but also generated a surplus of £11bn. As he pointed out, this is in sharp contrast to previous economic cycles, in which governments ran up deficits of hundreds of billions of pounds.
The case against his claim is simple – the Opposition argues that his prudence has always been more illusory than real and that he has tweaked the length of the economic cycle to make the figures look better. They point to the number of shifts in the definition of the economic cycle and other revisions that have made it easier to meet the golden rule of borrowing only to invest over the course of an economic cycle.
However much disagreement there might be over whether the figures have been 'fiddled', one thing is striking – almost everyone agrees with the rules themselves (the second rule is to keep net public debt below 40% of national income). This degree of consensus is unusual in such a hotly contested area. It suggests that the rules are here to stay and that while Brown might have had a choice over whether to publish and adopt them, the next chancellor will not. The rules have developed a currency of their own, and the next occupant of Number 11 will be judged by them, whether he or she likes it or not.
This will be a mixed blessing. On the one hand, they set a clear framework within which chancellors can borrow without attracting criticism. On the other, at the moment the Treasury itself is both actor and scrutineer. It not only sets the rules and then works to abide by them, but it is the body that decides when the economic cycle starts and finishes.
Under this system, claims made by the new chancellor about meeting the golden rule will always be mired in debate. This lack of credibility matters in the same way as lack of credibility over monetary policy mattered before 1997. Back then, people assumed that the government would manipulate interest rates to create an economic cycle that matched the electoral cycle. The idea that the government would stick to an inflation target just because it said it would held little credibility. So people based their inflationary expectations and wage claims on actual inflation and assumptions about government behaviour rather than the low inflation target the government said it was committed to. As a result, inflation was harder to control – lack of credibility had very real effects.
A similar set of problems apply in relation to fiscal policy. If people do not believe that the government will stick to its rules, there will be a bigger risk premium on government bonds (reflecting the fact that more might be issued than the rules would suggest). This makes it more expensive for the government to borrow money and therefore more difficult for it to finance investment into schools and hospitals. It also means that more money than necessary is spent on financing government debt, rather than investing in priorities. In addition, inflationary expectations might rise (reflecting the fact that lax fiscal policy would lead to inflation). If the next chancellor wants to escape this trap, then there is a simple option: allow independent setting and monitoring of the fiscal rules.
There are three ways that this could be done. The first is to write the rules into law – a model the Australians have adopted. However, this risks being a blunt instrument, preventing flexibility. And it doesn't deal with the credibility issues surrounding the definition of the economic cycle. The second is to live with the status quo but make the process of the Treasury defining the cycle more transparent. This would be unlikely to convince the critics.
The third option is for an independent fiscal authority to take on the job of managing fiscal policy. Its authority would come from the presence of eminent economists on its board and it would report annually to Parliament alongside the Budget and Pre-Budget Report. This option would enjoy a great deal of public confidence.
In setting up an IFA, the new chancellor would be following precedents set by his predecessor. On May 6 1997, just five days after gaining control over interest rates, Brown gave that power away. He vowed to take the politics out of interest rates by giving a new independent body, the Monetary Policy Committee, the task of setting interest rates to meet the government's inflation target. As this body was independent and made up of inflation-averse central bankers, it had credibility. People now believed that the government's inflation target would be met and set their expectations and wage claims accordingly.
The added credibility had real effects on people's behaviour and made a major contribution to macroeconomic stability.
The creation of the MPC worked because it took the politics out of decision-making in this crucial area. The same approach was adopted for competition policy, where the Office of Fair Trading was given an enhanced role with the explicit intention of removing ministerial involvement in day-to-day decision-making.
Concerns over the use of national statistics have also led to a Bill to make the Office for National Statistics more independent, although some commentators worry about whether an ONS with a board appointed by the Treasury can really be independent.
So is this a model that should be adopted across government? Certainly the use of independent or arm's-length bodies is nothing new. The first delegations of functions by the government were to bodies such as the Bank of England (1694) and the British Museum (1753). And it is a popular option with the many independent reviews that have sprung up across government:
- the Lyons' Review of local government finance suggested giving an independent body, possibly the National Audit Office, the responsibility for adjudicating whether or not government grant is fair to councils, is distributed appropriately and takes into account the costs of any new centrally imposed burdens
- the Leitch Review of skills recommended an employer-led commission to scrutinise employment and skills services, to ensure they are joined up and to make recommendations for improvement
- the Barker Review recommended a new national planning body for England to have the final say on major infrastructure projects, such as power stations
- the Eddington Review of transport recommended a planning commission to have the final say on major transport projects
- the idea of an independent board for the NHS has been floated to take the politics out of health. Ministers would set the NHS budget and strategic direction, but an independent board would be responsible for the day-to-day running of the service.
In each of these cases, the underlying argument is that devolving day-to-day running takes the political sting out of decision-making, allowing it be done on a more rational basis. For example, it is argued that an independent board for health would prevent ministers from being held responsible for every incident in such a huge organisation, reversing the desire of NHS creator Nye Bevan to hear every dropped bedpan echo across his department.
So as Brown prepares to move next door to Number 10 – and his economic record on everything from pensions to taxation comes under fire from the Opposition – it will be tempting for him to apply this principle across the whole of government. But he should be wary. 'Outsourcing' decisions is not a cure-all for our distrust of politicians. The circumstances in which it can work are actually quite limited.
When the chancellor set up the MPC, he gave it a single job: keeping the inflation rate within certain boundaries. He also gave it a single tool to use – interest rates. And the committee does not set the policy objective, it is the government that sets the inflation target. The MPC then sets interest rates to meet this target.
Accountability here is clear and simple: the committee has a single lever (interest rates) and a single objective (low inflation) and is directly accountable to the government for meeting that objective.
Where it gets trickier is when decision-making involves balancing potentially conflicting objectives. Even in the limited area of deciding on the affordability of new treatments, now devolved to the National Institute for Health and Clinical Excellence, the outcomes are intensely political – so much so that ministers have been drawn into debates about the approval of specific drugs such as Herceptin.
Here the decision-making process is neither simple nor clear. Put simply, taking these decisions out of the hands of politicians has not made them any less controversial.
This suggests two simple rules for the new prime minister to apply when considering recommendations from the range of policy reviews that have been running: first, can you provide the body with a single objective to fulfil and, second, does it have a simple, transparent mechanism to fulfil it?
Several of the recent recommendations fail that test. Both the proposed national planning body and the national transport infrastructure body would have to balance national economic needs with the interests of local communities – an inherently political task. The day-to-day running of the NHS and decisions about priorities, structures, staff pay and the building and closing of hospitals and other facilities involve clear trade-offs between the needs of patient groups and communities.
Here, there is no single clear objective and no single lever for an NHS board to pull. Instead, these decisions are intensely political and contested, not least because they often involve moral and value judgements.
At first glance the same issues would apply with an IFA. Either giving an authority control over a portion of fiscal policy to stabilise the public finances, or the power to require governments to take action would create a 'democratic deficit'.
There is another route however, which is to make the authority's role one of independent scrutiny – using the latest data to judge whether the government has complied with the fiscal rules. The appropriate model would be the National Audit Office, whose independence means that its views carry weight.
But it is worth remembering that the line between scrutiny and control is not always clearly defined. For example, on the surface, Lyons' recommendation that an independent body should be responsible for adjudicating whether the government grant is fair to councils looks like a simple scrutiny role. In fact, that's far from the case. It would involve having a view about what constitutes fairness – in itself an intensely political decision.
There are clear limits to the extent that politicians should hand over their powers to independent bodies. Outsourcing decisions will not add credibility or lessen controversy where they involve potentially conflicting objectives or a trade-off between competing interests. These are best made within the political sphere. Independent scrutiny does have a role, but only where that scrutiny can be applied to clearly established rules or objectives. An independent fiscal policy committee would meet that latter test. While we can depoliticise decisions where the public interest is unambiguous and gain credibility through independent scrutiny, we cannot depoliticise politics itself or the trade-offs it so often involves.
Ann Rossiter and Stephen Evans are respectively the director and chief economist of the Social Market Foundation
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