The Chancellor of the Exchequer is facing a tough balancing act in the forthcoming Budget. Rachel Reeves has inherited what she describes as a £22 billion fiscal hole amidst a wide range of economic and financial challenges, and has indicated that this implies ‘difficult decisions’.
Central to this spending capacity is the Government’s stance in relation to the UK’s Fiscal Rules. And after weeks of speculation, the Chancellor has confirmed her intention to amend these rules.
Current UK Fiscal Rules effectively constrain future borrowing to within 3% of GDP and require a downward trajectory in future debt as a share of national income over a five-year period.
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Strict adherence to these rules, in the context of an inherited fiscal hole, implied that the Chancellor would have to implement spending cuts and tax rises; essentially renewed austerity accompanied by fiscal tightening.
Upon taking office, the Chancellor initially doubled down on Fiscal Rules – presumably seeking to reassure markets as to her fiscal prudence. The Government has since been more ambiguous on the issue, and the associated uncertainty has had some impacts on borrowing costs.
There is a concurrent academic debate amongst economists as to the case for amending the current Fiscal Rules. There are legitimate arguments in both directions.
On the one hand, borrowing too much can create excessive risk exposure. It is therefore indisputable that some form of enforced fiscal discipline is vital.
These rules have served a purpose in mitigating the otherwise inherent short-termism in politics that could drive spending sprees for political expediency, with detrimental future impacts. Fiscal Rules also play a key role in safeguarding the UK’s credit rating and borrowing costs.
We have seen first-hand, via the Truss-Kwarteng mini budget, what can happen when credibility is lost and markets are spooked. This is costly to governments, businesses and home owners alike.
Nonetheless, there is a case for a revision to these arbitrary, self-imposed spending limits on the basis that they are no longer fit for purpose. This is because not all borrowing is equal; indeed there are cases where a failure to borrow and invest is counter-productive.
The current fiscal rules do not adequately capture and reflect emerging geopolitical and climate risks, for example. The rigidity of the current fiscal framework – with exceptions in only the event of a “significant negative shock” – fails to adjust to an ever-changing risk landscape.
This is problematic in that the framework is therefore failing to capture increasingly significant future orientated costs – in other words, there are costs of inaction.
Recent research by the Potsdam Institute for Climate Impact Research indicates that the cost of climate inaction will reach $38 trillion per year by 2049.
Analysis published in Nature journal shows that the world economy is already facing an income reduction of 19% until 2050 due to climate change; this applies even if Co2 emission were drastically cut down imminently. Furthermore, these damages are six times larger than the costs of mitigation needed to limit global warming to two degrees.
It is arguable that a refreshed fiscal framework for the UK should take account of these emerging, future orientated costs and focus on strategic investment in key areas that will simultaneously mitigate future risks while providing the UK with much needed investment.
The lack of investment in the UK – the lowest in the G7 in 24 out of the last 30 years – is a fundamental drag on the UK economy. Investing in core infrastructure has the potential to boost productivity across the economy, yet current Fiscal Rules would require that this is set to fall over the next five years.
A renewed focus on productivity and growth is vital. The Chancellor could continue to demonstrate fiscal prudence to assure markets, of course; but concurrently portray positivity and aspirational actions, including plans for strategic, productive investment in key areas such as green infrastructure.
The ultimate outcome of such investment would not only be economically and socially beneficial but would also be favourable for the UK’s future fiscal position.
- Dr Jodie Carson is a Professor of Strategic Policy at Ulster University