Next week the Chancellor of the Exchequer will set out his plans for tax and public spending. The public finances are in a fragile condition and the government rightly takes the view that without some tough decisions there is a risk of a repeat of the loss of market confidence we saw after Kwasi Kwarteng’s “mini-Budget” at the end of September.
Jeremy Hunt will face similar trade-offs to those his predecessors faced. Often the politically easiest items of expenditure to cut are those where the benefit of the expenditure – in terms of assisting economic growth or reducing demand for public services – will be seen in the long term. This is a debate that can become focused on the distinction between capital versus current spending. Capital spending is seen as “investment” and, therefore, inherently superior to current spending. When it comes to drawing up fiscal rules, a distinction is often made between the two by stating that we will only “borrow to invest”.
There is something in this but it is also an oversimplification. Spending on skills is generally current expenditure but the benefit is in the long term. It may be necessary to respond to demand on prison places by building another prison (capital expenditure) but current spending on an effective probation regime and rehabilitation support is more likely to reduce long-term demand on the justice system. An effective public health campaign (current spending) may do more long-term good than building a new hospital (capital spending).
When decisions on public expenditure have to be rigorously prioritised (as will be the case for the foreseeable future), how do we encourage politicians to focus more on the long term when the electoral pressures go in the opposite direction? What more could we do to increase the political costs of short-termism and increase the rewards for long-termism?
Before putting forward a suggestion, I want to make an observation about one of the things we have learnt in recent weeks. The Office for Budget Responsibility has become a vital institution. It was not that long ago (2010) that it was created and it has had its critics, especially on the right of the Conservative Party. But a few weeks ago a fiscal statement resulted in a loss of market confidence and the eventual resignation of both the chancellor and the prime minister in part because the OBR had been excluded from the process.
The OBR’s value is not a consequence of the accuracy of its forecasts but the reassurance that an independent organisation provides a transparent assessment of the consequences of government policy. The OBR requires governments to face up to reality (or, at least, an independent view of reality) and in doing so increases trust. Institutions matter.
[See also: Leader: Resolving the British dilemma]
Let me return to the issue of public expenditure and strengthening the incentives to prioritise spending on items that will bring about long-term benefits.
Imagine a system whereby a department submits its spending plans to an independent organisation. That organisation would then examine the individual items and make an assessment of the likely contribution of the programme to higher economic growth or reducing demand on public services (whether those run by that specific department or other departments). This will not be an exact science but it should be possible to reach a broad categorisation of the long-term benefits – perhaps a range of one to five, one being the most beneficial in the long term and five the least. Credit could be given for a strong evidence base or a well-developed programme of evaluation. Over time, our independent organisation could return to its previous classifications to see if its assessments were justified by the subsequent evidence, enabling it to refine future analysis.
Departmental spending could be evaluated annually, with expenditure attributed to each of the five categories. The department and its ministers would be incentivised to move more of its expenditure into higher categories, the Treasury more incentivised to reward those departments capable of doing so. The markets may even become more relaxed about government borrowing if they were convinced that expenditure was going to areas that would assist growth or reduce spending pressures, thus making the public finances more sustainable in the longer term.
It is, of course, already the case that departments make “spend-to-save” arguments to the Treasury but an institutional change of this sort would provide additional rigour and transparency to the process. We could do this by strengthening the National Audit Office, allowing it to look forward as well as back, or creating a new institution – the Office for Spending Evaluation, say. If one prefers, this could be framed as a “demand reduction taskforce” or even a venture fund.
Public service reform has to return to the centre of our political debate and one element of this is about taking a more preventative approach, solving problems “upstream” as much as possible. Sustaining that approach is not easy but we can use institutions to strengthen the incentives on ministers to focus on the long term. We already have the National Infrastructure Commission, which makes a valuable contribution to our thinking on infrastructure. We could go further.
Deteriorating economic conditions and the fiscal recklessness of the Truss administration mean that tough spending decisions are being made. While ministers are at it, they might want to think about strengthening our institutional arrangements to ensure that those decisions are not just tough but wise.
[See also: Ha-Joon Chang: “Talk of a ‘fiscal black hole’ is an insult to the concept”]
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