John McDonnell and the Fiscal Charter

Clearly some in the Parliamentary Labour Party are finding it difficult to come to terms with the election of Jeremy Corbyn as leader. Confusion and anger reign. 

But the political facts are straightforward: those that voted in the new leader want to shift the debate away from the Chancellor’s chosen framing of the threats facing Britain: public debt, the deficit and the welfare state. Instead, Corbyn supporters believe that the crisis was caused not by those on benefits, but by the City of London - it’s the finance sector that should be regulated and re-structured, not the public sector. They’re angry that the Chancellor is using the crisis as an opportunity to shrink the state, to privatize the NHS and reward Conservative supporters in the City. 

But the Parliamentary Labour Party has good reason to be concerned. The shadow chancellor has for political reasons been ambivalent about whether to be boxed in by the Chancellor as a ‘deficit denier’ or to oppose the so-called ‘Charter for Budget Responsibility’. Most economists have sighed with relief at the news that he will not walk into the Chancellor’s trap, but will instead vote against the ‘Charter’.  

By opposing the government, John McDonnell will also oppose the stance taken by Gordon Brown.  It was he who, unwisely, introduced the Fiscal Responsibility Act in 2010. This said that public sector net borrowing must fall each year below the level of the previous year for the period 2011-16.  

As soon as he took office  George Osborne repealed this law, having in Parliamentary debate called it “vacuous and irrelevant”, as the FT reminds us once more today .  ( In debate, Mr Osborne also called Mr Brown’s Bill “a completely feeble stunt”). The FT and most economists judged the Chancellor right to repeal Brown’s 2010 Act, or it would have “forced him into further austerity in 2012 and 2013.” 

And what of the ‘Charter’ to be debated later today? John McDonnell argued correctly in his Party Conference speech that the Charter is nothing more than a stunt. The Treasury describes it simply as “an Autumn 2015 update.” This “update” has no constitutional significance whatsoever and will have only marginal legal impact since it can be changed at will by a simple vote of the House of Commons. 

When the Chancellor first mooted the idea of the Charter in June – ahead of his Mansion House speech – we were told that he intended to outlaw budget deficits by legislation.  In fact the Mansion House speech made no mention of legislation. Instead Osborne referred opaquely to a “a strong new fiscal framework to entrench this permanent commitment to that surplus” which he argued, will enable “our nation to entrench a new settlement …” (my emphasis).

It’s an idea that is older than Lord Palmerston’s Victorian Commission for the Reduction of the National Debt convened 150 years ago! 

But it turns out that nothing will be entrenched in legislation after all. Instead Parliament is invited simply to vote on a Charter – a legally flimsy, easily voted down and politically useful instrument.  And interestingly, in one respect Osborne’s Charter is not as fiscally conservative as Gordon Brown’s was: it requires a budget surplus (of unspecified size) in “normal times” and does not require “balancing over the cycle” in line with Brown’s “golden rule”.   But crucially, whereas Brown’s golden rule allowed borrowing for investment purposes, Osborne’s proposed new rule would be far more damaging as it would prevent any borrowing for investment, as well as for current budget purposes.

Mr Osborne’s Charter gives himself, however, plenty of leeway for running a deficit over the period 2010 -2019.  In effect, he defines this period as “abnormal times” to justify his failure to “eliminate the deficit”. 

Back in 2011 he opposed “entrenching” fiscal responsibility into European law. The Prime Minister was persuaded not to sign the European Union’s “Fiscal Compact”. By the use of the veto to block the new EU-wide fiscal responsibility treaty, David Cameron incurred the wrath of his European partners. Britain (rightly in that case) stood out from the 23 EU countries that had signed up for a deal that conferred what the Guardian called

intrusive rights on European institutions to enforce budgetary policy in countries breaking the euro's debt and deficit rules, as well as quasi-automatic penalties for delinquents.

Finally, what of the economics of all this political bluster?  First, we must be clear. No chancellor can ‘eliminate the deficit’. The deficit is a function of the wider economy. Only when the wider economy recovers fully, will the deficit dissolve.

Second, most economists – including those that “lashed Corbynomics” - believe that at times of private sector weakness, governments should compensate by expanding public spending. The reason is straightforward: government spending (unlike most household spending) generates its own income (in the form of tax revenues) and pays for itself.  

Third, interest rates on government bond sales are at historically unprecedented low levels. Locking in these low rates for thirty or fifty years is sound economics. It enables government to borrow for long periods of time at rates that are effectively negative, taking inflation into account. This borrowing – if invested in e.g. high speed broadband infrastructure – would provide a tremendous boost to the private sector, and deepen the recovery. 

And of course Mr Osborne knows all this. After all he will be financing HS2, the renewal of Trident and the building of nuclear power stations by issuing bonds at low rates of interest. 

Whether or not you agree with these specific projects, investing in our country's future is what entrepreneurial states can and should do.