Osborne Boldly Goes for a Budget Surplus

What is said in the conference hall, rightly, normally stays in the conference hall. The things politicians say to please the party faithful often do not easily translate into practical policies.

The question is whether George Osborne gave us something last week that will prove to be more durable and significant in terms of future economic policy in Britain.

It was not, in spite of its short-term appeal, the chancellor’s pledge to try to freeze fuel duty between now and the election. It was not, either, the bringing forward of the second phase of the Help to Buy scheme, on which more I hope next week.

No, it was his promise that “when we’ve dealt with Labour’s deficit, we will have a surplus in good times as insurance against difficult times ahead”.

“Provided the recovery is sustained, our goal is to achieve that surplus in the next parliament,” he added. “That will bear down on our debts and prepare us for the next rainy day.”

A couple of sentences in a speech does not amount to a fully-worked policy. But the chancellor’s advisers produced a four-page briefing note to accompany it and the aim is to work this up into fully-fledged fiscal mandate by the May 2015 election.

That new mandate will not necessarily appear in autumn statement or budget documents between now and the election. The constraints of coalition mean that, because this is so far only Tory policy, the Liberal Democrats would also have to adopt it for it to becoem government policy.

What does it mean? At its simplest, it means the Tories will go into the next election promising a budget surplus before the end of the next parliament. In 2019-20 or 2020-21 instead of public sector net borrowing, there will be a debt repayment.

Is that possible? Current projections from the Office for Budget Responsibility show that public borrowing, £115.7bn in 2012-13, will be £42bn by 2017-18. Osborne believes that, even without further real cuts in overall public spending, that trajectory will lead to a budget surplus in at least one of those two fiscal years around 2020.

That, in itself, is no great shakes. A temporary budget surplus, after years of austerity and in the context of a recovering economy is rarel but not unprecedented. It happened in 1969-70 and 1970-71, then again in 1988-89 and 1990-91 and, most recently, in 1998-99, 1999-2000 and 2000-01, the last one helped by £22.5bn of 3G mobile phone proceeds.

Temporary surpluses like this are, however, the political equivalent of a huge itch that has to be scratched. Even if chancellors do not necessarily think that a budget surplus is better spent in tax cuts or higher public spending, you can bet plenty of their colleagues will, particularly when there are elections looming.

Roy Jenkins, Labour chancellor during one temporary surplus period, was blamed by some colleagues for losing the 1970 general election.

Longer-term surpluses – prolonged periods of debt repayment – are much rarer. Successive governments reduced the debt overhang left after the Second World War mainly by allowing its real value to erode, rather than cutting it outright.

For a sustained period of falling debt you have to go back to the late Victorian era, and famous chancellors like William Gladstone, Benjamin Disraeli and Lord Randolph Churchill, as well as not so famous ones like Sir William Vernon Harcourt and Sir Michael Hicks Beach.

Can Osborne recreate those Victorian values? Fiscal rules do not have a great reputation. Gordon Brown’s golden rule (only borrowing to fund investment) and sustainable investment (keep debt below 40% of gross domestic product) disappeared in a puff of smoke when the crisis hit.

The coalition’s original rules, to eliminate the current budget deficit and have debt falling as a percentage of GDP by the end of the parliament, have had to be stretched out well beyond the election.

The fiscal rule, or mandate, Osborne has in mind this time is that, subject to economic cirumstances, the government will run a budget surplus, will repay debt. “Subject to economic circumstances” sounds woolly. The mandate could get around it by targeting cycically-adjusted borrowing, though that opens up the kind of can of worms that discredited Brown’s golden rule even before the crisis. Deciding where the economy is in the cycle is a matter of judgment and, even if that judgment is devolved to the OBR, there would be plenty of room for doubt and debate.

Instead we might see Osborne taking a leaf out of Mark Carney’s book. So just as there are “knockouts”, mainly relating to inflation, when the Bank of England’s forward guidance on interest rates will no longer apply, so there would be knockouts in which the government would no longer have to run a budget surplus.

So, if unemployment rises above a certain level, or growth drops below a certain rate, the chancellor would not have to run a surplus; the so-called automatic stabilisers of allowing spending to rise and revenues to fall would apply.

Is running a budget surplus a good idea? It depends where you start from. Brown’s 40% debt rule was not necessarily a bad one, though it proved fragile, and countries that went into the crisis with lower debt levels also found themselves in trouble.

But the fact is that, on almost any scenario, Britain in 2020 will have significantly higher government debt – both in absolute terms (perhaps £1.7 trillion) and relative to GDP (over 80%) – than was the norm for the 40 years leading up the crisis.

That leaves Britain with little room to cope with emergencies or face the pressures of an ageing population, which the OBR expects to push debt to 100% of GDP over the next 50 years. Aiming for a sustained surplus, given this, is a good idea. If you think of the crisis as the equivalent of a war, peacetime is when you unwind the rise in debt that occurred as a result of it.

Will it ever be achieved? 2020 is a long way away. Politics will change – the Tories might not be in government – and so will the economy. But there is a chance, at least, that we have just witnessed the launch of what could be a profound change in the way governments approach the public finances.

This piece is cross-posted from EconomicsUK.com with permission.