Fiscal Rules: A Political Attack on Economic Logic

The IFS has warned that Labour and the Conservatives’ commitment to arbitrary fiscal rules will not prevent an unsustainable debt burden. So why are the two main parties pushing forward with them?

According to the Institute for Fiscal Studies (IFS), the UK is facing an extra £28bn of public debt by 2028–9. This figure is based on two assumptions. One, its current expenditures will remain the same. Two, its yearly growth will amount to 1.5%. The problem? There’s little evidence to suggest the economy will achieve even that. To compound the issue, neither Labour nor Conservative policy shows a way out of this bind – also per the IFS.

The Figures in Context

Let’s be clear: 1.5% yearly growth is in itself a long-term catastrophe for the economy. Indeed, it’s the lowest rate of growth the UK economy has experienced since the Great Depression. Its effects are perhaps best represented by two recent economic developments. First, the recession of late 2023, comprising the successive economic contractions of Q3 (Jul to Sep) and Q4 (Oct to Dec). Second, this year’s uneven economic recovery, which saw 0.6% growth in Q1 (Jan to Mar) and 0% at the opening of Q2 (Apr).

What’s going on here? Put simply, the economy is groaning under the weight of almost a decade-and-a-half of dubious socio-economic Conservative policy. Average growth during the Conservative’s 14 years in power has averaged none other than 1.5%. (Under New Labour, yearly GDP growth averaged 2.2%, even when accounting for the Great Recession years.) Just take a look at the main reasons given for the recession of late 2023. A decline in household spending due to the cost of living crisis. Turbulence in the health sector because of junior doctor pay disputes. Declining school attendance. These are all factors whose effects sensible government policy could have mitigated.

To be fair to the government, even sensible policy can’t control the weather. According to analysts, the rainy weather was likely a factor in April’s economic slowdown, causing a decline in retail sector profits, manufacturing and construction output. Indeed, economists predict that May and June will show an economic upturn in line with the improved weather. But is it really sensible to let excessive rainfall undermine the economic health of the United Kingdom, of all countries?

In short, the shaky foundations of the UK economy have ensured that it’s condemned to vacillate between sluggish growth and contraction. That the rain managed to vanquish it is just the mouldy cherry on top. It’s easy to see why the IFS is sceptical whether the economy will average even 1.5% growth by 2028–9, and, by extension, why it thinks that the £28bn black hole might end up being far bigger.

The Best-Case Scenario

Let’s assume for a moment that the £28bn figure is what we’ll get. According to the IFS, even this increase in the UK’s debt hole will be stark. If growth continues to languish as the debt hole continues to deepen, the next government will face two stark choices: raise taxes or bring back austerity. Both the Conservatives and Labour have ruled out the first choice. They’ve also ruled out the latter (although whether austerity ever ended under the Conservatives is highly debatable). Their decision leaves open one other option: borrowing.

At first glance, borrowing even more while sinking in debt seems like a terrible idea. But borrowing only adds to the debt hole if the money is used irresponsibly. Using it to fund massive tax cuts, for example, is the equivalent of pouring money down the drain. But if borrowed money is invested sensibly – emphasis on ‘invest’ – it can create a net gain in the future over and above the initial debt.

Picture, for example, the government using borrowed money to fund the development of domestic green industries. (Indeed, this was Labour’s position before it decided to row back on it.) Amongst other things, strong domestic green industries would ensure lower energy bills for households by insulating the domestic energy supply from global price fluctuations. Households would then have more disposable income, which in turn would boost the struggling service and retail sectors.

In short, investing borrowed money sensibly can lead to healthy national growth. Not so terrible an idea, after all. Indeed, Paul Johnson, director of the IFS, has claimed that the only way Labour or the Conservatives can avoid both austerity and tax rises is if the economy experiences a sudden spurt of growth.

The Fiscal Reality

Alas, instead of working to rectify poor economic policy and finding a logical path to consistent growth, both parties have committed themselves to a fiscal rule which renders that goal all but impossible. This rule states that the government can borrow money if and only if public debt, as a share of GDP, is forecast to fall by the fifth year of a five-year forecast (2029, in today’s case). The percentage at which the debt-to-GDP ratio is forecast to fall (0.3%, or £9 billion, by 2028–9, according to recent forecasts) is known as the chancellor’s headroom – in other words, the cash they can borrow and inject wherever they deem fit.

You’ve probably already noticed some problems here. First, £9bn isn’t enough to plug the looming £28bn black hole. Second, even if the government uses the £9bn to mitigate the effects of the debt hole, then that’s £9bn less they can invest into economic development. Third, coming up with a long-term strategy is impossible so long as the government insists on sticking to this medium-term fiscal rule. The result? Square one: austerity, tax rises or baseless hopes for dramatic economic growth.

Both Labour and the Conservatives are obviously aware of the unworkability of their own positions. As the IFS points out, past governments have freely gamed their own fiscal rules. But why? Quite simply, because they’ve had no other choice. Sticking to their arbitrary fiscal rules would leave all their fiscal plans – and thus the economy – in stasis. No government can make plans according to a five-year window in which debt is merely likely to fall by X amount. It would be twiddling its thumbs, forever anticipating the future without doing anything to alter it. What we end up with, then, is a fudge: a half-baked fiscal rule that no party can follow properly yet implements just enough to cause a whole lot of damage. It’s the same logic that drove Osbornian austerity, whose legacy still looms large over this debate.

Politicking vs Economic Logic

Both main parties’ conscious adherence to irrational economics has its roots in post-2008 politicking. Following the 2008 financial crisis, the 2010 Conservative–Lib Dem coalition laid the blame for the crisis not on the backs of bankers and their reckless speculations but on a Labour government that had allegedly overspent on public services and left the public coffers empty. Of course, the billionaire media moguls were only too happy to repeat these claims ad nauseam. Why should their wealthy comrades in the City ever have to suffer from their poor decisions? Why should they ever face people knowing the truth that the public coffers never were empty, and never could be, so long as the Bank of England could keep printing billions upon billions of pounds to bail out the banks?

But when a lie is repeated enough and never decisively rebutted, it sticks. A prominent question in all post-2010 election campaigns has been ‘how can we afford this?’. Public debt has become a bogey topic. Yet Labour refuses to tackle the misassumptions behind these questions. Instead, it talks about borrowing only whilst promoting arbitrary fiscal rules that would supposedly ensure they don’t, in their Shadow Chancellor’s words, ‘max out the credit card’. Why? Because proving that there’s no ‘national credit card’ doesn’t deliver the cheap poetic justice that turning the Conservatives’ own myth against them does. Politicking, not logic, trumps all.

What makes this situation tragic is that at one point Labour seemed prepare to counter this myth through its pledge to invest £28bn a year of borrowed money into the UK’s green energy transition. We’ve already seen a snapshot as to how that money could benefit the economy in the long term. Yet as the spectre of the election descended, so did the spectre of the Conservative’s fiscal rules and, by extension, the accusations of economic irresponsibility Labour would no doubt have faced were they to push ahead with their original investment plan.

Labour could have fought back against the backlash, shown how it’s grounded in irrational economic thinking. They could have argued that the right tax rises (think capital gains and wealth taxes), alongside sensible borrowing, would create an even clearer path for economic recovery. Alas, they donned the same shackles as their opponents instead.

It’s hard to blame their caution, to an extent. Both the arbitrary fiscal rules Labour have accepted, as well as perceptions of their fiscal irresponsibility, had a decade-and-a-half to gestate through a mixture of suspect, yet dogged, economic arguments by the Conservatives. Yes, Labour has abetted the dissemination of this pernicious accusation through their weak responses to it. But therein lies the tragedy: even if these fiscal rules go against its instincts, the Labour Party of today remains in thrall to them. The consequence? Sensible policy must give way to ‘political reality’: that these fiscal rules must always come first – no matter the cost.