Insights

After years of frugality, economic policy is set to go the way of Trump

Boris Johnson, if he becomes prime minister, would make a UK-US free trade deal a top priority. This would involve Britain agreeing to replicate areas of regulation, and perhaps contentious foreign policy, of the world’s largest economy.

There is a separate area of economic policy where Britain also looks set to imitate the United States: its tax and spending plans. Having gradually reduced the fiscal deficit for the nine years, the new government looks set to reverse this trajectory.

This would re-establish parallels in UK and US tax and spending plans that have been in place for most of the past 40 years. Since 1979 the British and American governments have largely run deficits, averaging 3 per cent of their respective economies. While there were brief surpluses in the late 1990s as the baby-boomers reached peak tax-paying age, the idea of a balanced budget has historically proved more aspirational than deliverable.

This parallel behaviour began to breakdown down in 2017 when Congress passed the President Trump’s tax cuts and jobs act. That set the US government on a path to run an average deficit of 4.3 per cent for the next decade. While the White House contends that higher growth will reduce the scale of this deficit, the independent Congressional Budget Office is unconvinced.

By contrast, Philip Hammond has kept Britain on a trajectory towards running a balanced budget by 2025. His Charter for Budget Responsibility is founded on two very different calculations. The political calculation is that disciplined control of the UK’s public finances is the dividing line that Conservatives offer over Labour. The economic one is that with the demands of ageing population set to rise in the next decade and unemployment at multi-decade lows, now is not the time for public sector largesse. These calculations seem set to be sacrificed at the alter of Brexit.

The political merits or demerits of ditching fiscal restraint are for others to debate. However, if the UK is going to follow the US with higher deficits, there are three things for a new chancellor to consider.

Firstly, when it comes to spending projects, think small. Mr Johnson has already shown a penchant for the grandiose, headline-grabbing project: a new London airport on the Thames; a bridge to connect Northern Ireland to Scotland; enthusiastic support for Crossrail 2. Rushing into these would be a mistake. The most compelling reason for additional spending at this point in the economic cycle is to lean against the effect of no-deal Brexit.  The UK needs shovel-ready projects, not long-lead infrastructure. Filling holes in roads and broadband coverage makes more sense than big projects whose impact by October will be on Whitehall paperwork, not jobs and incomes.

Second, any sustained increase in the deficit may mean that interest rates need to rise. With Britain near to full employment, any enlarged role for the state or significant tax cuts is likely to push up inflation. As President Trump has found with the Federal Reserve’s increase in US interest rates in 2018, an independent central bank may not find its mandate consistent with the economy going “gangbusters”. Nor should it.

Finally, if looser fiscal policy is to be pursued, a new chancellor will need to determine the balance between spending increases and tax cuts. There was an informal rule under the coalition and subsequent Conservative governments that fiscal repair was to be achieved through 80 per cent contribution from spending cuts and a 20 per cent contribution from tax increases. Will this prove symmetrical on the reverse journey? With the risk that any primary legislation to introduce these changes may be hijacked by MPs seeking to block a no-deal, the government will be nervous about providing a vehicle for ramming the no-deal bus off the road.

The immediate future may be fiscal, but fiscal isn’t foolproof. The new chancellor should take note.

A version of this piece was published in The Times.

Simon French

Economics & Strategy