The chancellor is likely to fail his fiscal targets when he announces the Autumn Statement on Wednesday. He needs to radically rethink the way the debt rules are designed and utilised if they are to endure for any length of time
In July this year prime minister David Cameron reinforced the coalition priority: ‘We have to deal with our deficits and we have to have sustainable debts. I can't see any time soon when the pressure will be off. I don't see a time when difficult spending choices are going to go away.’
In the Autumn Statement on Wednesday, George Osborne will offer a bleak prognosis on his targets – the mandate is to eliminate the structural deficit within five years and to have net public debt falling as a proportion of GDP between 2014-15 and 2015-16. An economic recovery far slower than expected means the chancellor is likely to fall short of both.
Yet the coalition's problems go deeper than this. Even if the chancellor were to meet his fiscal targets, gross government debt would still be in the danger zone. Sustained high levels of public debt are a serious cause for concern; they limit the government's ability to respond to economic crises, encourage pro-cyclical fiscal policy and damage growth.
Evidence suggests that debt levels exceeding 85% to 90% of GDP could reduce the annual growth rate by up to one percentage point. Under the chancellor's current plans, gross debt is expected to exceed 90% of GDP by 2013-14.
To reverse this trend, the deficit needs to return to a sustainable level where the nominal growth rate rises faster than the level of public debt. This is no small task, with the government borrowing £8.6bn in October (rather than the £6bn forecast), and deficit cuts ‘taking longer’ than expected.
Without a surplus capable of servicing its debt, the government will continue down a debt spiral of unsustainable borrowing. Debt servicing will need to be funded by borrowing, which will then accrue interest and further increase the debt burden.
Some economists challenge the significance of on-going deficits. After all, the primary surplus has failed to cover interest payments on public debt in 22 of the last 28 years. However, recent fiscal policy has led to gross debt increasing as a proportion of GDP in every year of the past decade, rising from 37% in 2002 to almost 86% today.
From 1998 to 2008 the UK had two fiscal rules: a golden rule to ensure budget balance, and a sustainable investment rule to constrain total debt. These rules failed to prevent the increase in government debt in the UK between 2003 and 2008, even before the global financial crisis struck. Even in the boom of the mid-2000s government debt grew faster than GDP. Overseas, fiscal rules have had greater success in ensuring fiscal discipline.
So what does this mean for Osborne? Firstly, the UK needs a better fiscal rule. Debt rules with room for creative accounting do not work. Under the golden rule only operational, rather than total, expenditure was measured, allowing the Labour government to continue to borrow for investment and still maintain debt at the 40% ceiling.
Secondly, the government needs to be truly bound by its rules, particularly when they become difficult or inconvenient. Arbitrary debt targets, such as the sustainable investment rule, are too easily changed and should be avoided.
The chancellor should implement fiscal policies with enough flexibility to allow debt to buffer unexpected shocks, while still maintaining credibility with medium-term rules. It could fall to the Office for Budget Responsibility to negotiate the particular rules with the chancellor; any rule must be theirs to enforce, not the chancellor's to break.
Osborne has to put the level of public debt on a downward trajectory or long-term growth could be at risk. The right fiscal rule implemented in the right way could make a real difference.
The Swiss ‘debt brake’ and the Swedish tri-annual expenditure ceilings have proved successful in keeping debt in check overseas. It is clear, however, that Osborne will have to radically rethink the way debt rules are designed and utilised in the UK if they are to endure longer than his present targets.
Politicians must reform fiscal institutions to ensure that they do not continue to live out the maxim that 'rules are there to be broken’.
Cathy Corrie is a researcher at the Reform think-tank. Reform has today published a report on Long-term fiscal sustainability
