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RADIO 4
CURRENT AFFAIRS

ANALYSIS
BENDING THE GOLDEN RULE?
TRANSCRIPT OF A RECORDED
DOCUMENTARY
Presenter: Diane Coyle
Producer: Zareer Masani
Editor: Nicola Meyrick
BBC
White City
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London
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020 8752 6252

Broadcast Date:
Repeat Date:
CD Number:
Duration:

11.03.04
14.03.04
PLN 409/04VT1009
2723

Taking part in order of appearance:


Kenneth Clarke, M.P.
Former Chancellor of the Exchequer
Ed Balls
Chief Economic Adviser to the Treasury
Bridget Rosewell
Chairman of Volterra Consulting
Former Adviser to the Treasury
Sir Alan Budd
Provost of Queens College, Oxford
Former Chief Economic Adviser to the Treasury
Laura Tyson
Dean of the London Business School
Former Chief Economic Adviser to President Clinton
Gerald Holtham
Chief Investment Officer of Morley Fund Management

Robert Chote
Director of the Institute for Fiscal Studies
Katinka Barysch
Chief Economist at the Centre for European Reform

COYLE: Next weeks Budget could mark a


turning point for the Chancellor of the Exchequer. Gordon Brown has
always made prudence his watchword. But hell end up borrowing around
37bn this financial year, and some critics believe hes losing his grip on
the governments finances. Among them is Kenneth Clarke, his
Conservative predecessor as Chancellor.
CLARKE: For his first couple of years, Gordon
was the ultimate iron chancellor. Then of course, perversely, as they got
more confident and as they won the confidence of the city, from about
2000 onwards they completely changed tack. And Ive been very critical of
Gordon ever since then for being irresponsible and profligate and steadily
getting the public finances into a worse state.
BALLS: We are showing that you can deliver
stability in the economy and have strong public services. I think it would
have been unthinkable in Ken Clarkes time to have the lowest level of
unemployment since the early 1970s, to have the lowest level of interest
rates for mortgage payers since the early 1970s, and to have the lowest
level of debt interest payments on the national debt since I think 1913.
COYLE: Ed Balls, the Chief Economic Adviser
to the Treasury, and one of the main architects of the rules Gordon Brown
set himself for keeping government borrowing under control.
BALLS: We set out clear fiscal rules which we
stuck to every year for the longest period of a sustained and stable fiscal
framework in Britain in the post-war era. We repaid more debt in one year
99/2000 than all the debt repaid cumulatively by all governments
between 1945 and 1999, the result of which is that we have the lowest level
of debt of any of the large industrial countries.
COYLE: Prudent or profligate? The strongest
government finances amongst the major economies - or a widening gap
between public spending and the tax revenues available to pay for it? In
1997 many people expected the first Labour Chancellor for 18 years to
announce big increases in expenditure on services like health and
education. But Gordon Brown insisted hed stick to the tight spending
plans Kenneth Clarke had already set for the next three years. And in case
anybody still doubted his toughness, he introduced new rules for the public
finances, in addition to those already imposed on EU countries by the
Maastricht treaty. The Chancellors golden rule says the government can
only borrow money for investment, or capital spending. Taxes have to raise
enough to pay for its day to day spending and running costs. He also
brought in a second rule to limit the amount of this borrowing. Former

Chancellor Kenneth Clarkes rule just said the government had to balance
its budget over a number of years.
CLARKE: Gordon altered the rules for the sake
of it really. His public spending rules the golden rule and all that kind of
thing were also splendidly flexible. I mean they were looser than mine.
The golden rule is what you make it to mean. Its anybodys guess what
you really count as capital spending and what you count as current
spending. And so despite his tough two years, hed got himself a more
flexible set of rules when it came to launching on his spending spree,
which he did.
COYLE: Do you think hes actually going to
break his own rules with this spree?
CLARKE: I think hes going to break even his
own rules. Hes produced his red books with the figures for the public
finances in a pretty generous, slightly obscure fashion, and hes still going
to break them. And hes also going to break the one thing that he and I
used to joke at the expense of the rest of the House of Commons because
we both agreed with it hes going to break the Maastricht rules as well.
Hes about to go through the 3% of GDP limit on fiscal deficits. I always
took the view of the Maastricht limit that it was perfect commonsense for
any Conservative chancellor and that I couldnt conceive of any
Conservative chancellor ever wanting to go above 3% of GDP. Well we
all know that Gordons about to sail above that.
COYLE: The Maastricht rule, which applies to
all member countries of the EU, says the government shouldnt borrow
more than 3% of GDP in any single year. Britain has now joined France
and Germany in breaching this limit, although in our case only by a
fraction of a percent. But how much does slipping the restraint of all this
fiscal bondage, and missing any of the targets, really matter? Economist
Bridget Rosewell is chairman of Volterra Consulting and a former adviser
to the Treasury.
ROSEWELL:
I dont think it really matters from a
sort of economy point of view whether its missed by a little bit. I think it
does matter from, if you like, a political economy point of view in the
sense that Gordon Brown has hung his hat on meeting these particular
targets and he looks weak, inadequate if he misses them.
COYLE: And if he does lose credibility by
missing them, is that actually harmful for the rule itself and his ability to
run a tight fiscal policy in future?
ROSEWELL:
Yes, I think it is. Losing credibility is
the sort of worst thing you can do if youre a chancellor really. So I think
it weakens the whole status of the Treasury if putting in place these rules
and at the sort of first test, the first hurdle you fail I think thats
actually
quite significant.
COYLE: But it does seem very hard for
politicians to stick to any kind of rule that means they keep spending in line
with tax revenues because we see this not only in the UK but in other
countries too.
ROSEWELL:
All rules will always have exceptional
clauses. If things go wrong, if there are unexpected shocks, you should be
able to have some flexibility around that. The rule which Gordon Brown
has given himself is over a cycle. This says that he needs to balance his

taxes and revenues over that cycle. I think the worry is that he risks
breaking his rule in a period where there has not been a recession, so his
difficulty is that he had his spending plans and although the economy is
keeping growing it is not generating the tax revenues which enable him to
meet his rules. That is a more structural worry and hes right to be very
concerned about it.
COYLE: It might sound a bit like a circus trick,
but there are good reasons for this cyclical balancing act. When theres a
recession, government spending automatically rises because of higher
unemployment, and tax revenues automatically fall because incomes and
profits are down. So even if the Chancellor does nothing, borrowing will
rise during a downturn and should just as inevitably fall when the
economys growing fast. This is why the golden rule is meant to average
out the good times and the bad. Sir Alan Budd, Provost of Queens
College, Oxford, was Chief Economic Adviser to the Treasury from 1991
to 1997.
BUDD:
The idea of the business cycle is that
it allows you to borrow more when the economy is in a recession and less
when its booming, and that is very, very sensible otherwise youd be
raising taxes and cutting public expenditure as the economy was turning
down. Theres no sense in that at all. So I think that idea thats embodied
in balancing over the cycle is sensible, but it does cause difficulties in
knowing whether youre succeeding or not because of the difficulty of
knowing when a cycle begins and ends. And theres also a risk, which is a
current risk, that you may over a cycle balance, if you take all the years
together, but start with a very large surplus and end with a very large
deficit. So though youve met the rule, youve actually left yourself with a
position which is not sustainable.
COYLE: Is that the situation were in now?
BUDD:
There is a risk that thats how we will
be; that if we do balance over this cycle, it will be because we started with
a large surplus and end with a rather large deficit. And so that means that
if you look ahead something has to be done about the current balance
between spending and taxation. And you can only stop worrying if you
believe that this deficit is not so much cyclical as temporary. In other
words, that its partly a matter of expenditure being very high because of
such matters as the Iraq War and other rapid increases in some forms of
social expenditure, and the revenues are low for reasons we dont quite
understand, but you hope that they will come back to normal before too
long.
COYLE: It isnt only in Britain that some
people are starting to get worried about going into the red. Some other big
economies in the so-called G7, the rich industrial countries, are facing the
same problem. Kenneth Clarke sees this as a dangerous change in the
international climate.
CLARKE: The mid 1990s were a time when
most of the G7 were on their way to steady growth with low inflation and
keeping there. The governments of John Major, Bill Clinton, Mitterand,
Kohl were producing pretty good economic results. And now, I think, the
American, British, French and German governments are in the hands of
totally irresponsible people who keep persuading themselves - and then
their public - that somehow it doesnt matter that you try to solve every
problem by spending public money and that your deficits soar. I do worry
whether this is sustainable and what the different major economies are
going to do to get themselves out of the fiscal problems theyre piling up.

COYLE: If they dont, and we are in a situation


where all these major economies have large deficits, what do you see the
consequences being?
CLARKE: Well theyre bound to have the effect,
at the very least, that growth will be less than it otherwise would be. I
mean what happens if you pile up public borrowing too high, particularly if
it coincides with a time when as in America and the United Kingdom
private household borrowing is going too high, is it drives up interest rates
and it drives up taxation. And the effect of both of those is that it slows
down growth and, if it goes too far, in the end it works through to peoples
day to day lives, and if you get it completely in a mess you start getting a
recession.
COYLE: When he became Chancellor in 1993,
Kenneth Clarke inherited a budget deficit he thought had reached crisis
levels. He decided to increase taxes and limit public spending. At about the
same time, across the Atlantic, Laura Tyson, now Dean of the London
Business School, became President Bill Clintons chief economic adviser.
She too had to grapple with a stubbornly large government deficit.
TYSON: The structural problem, it was
thought, endangered economic prosperity in a couple of ways: one, by
squeezing out private investment over time through higher interest rates;
and by increasing US dependence on foreign lending to the United States.
So if you believe the numbers that weve had something like and the
numbers keep getting larger a ten trillion dollar shift from five trillion of
surplus to five trillion of deficit, or a recent number I saw was more like
twelve trillion over a decade, well you can figure out using those numbers
what the reduction in investment would be about half of that and what
the additional foreign lending to the United States required to finance the
larger current account deficit would be. And then you say alright do we
want to set ourselves in a trajectory where we have to depend even more on
the rest of the worlds savings.
COYLE: And it affects the rest of the world
too, does it, because we also get higher interest rates, America being so
large in the global markets?
TYSON: Yes, that would be the case. I mean
the estimate now is that this could mean a percentage point on US on
global interest rates, so thats a lot. And it really does come from the fact
that the US is such a large player in terms of absorbing global savings. Its
almost You could liken it to a foreign aid programme for the United
States whereby the central banks of Asia accumulate these dollar assets to
the tune of two and a half percent of the worlds GDP outside the US, and
the US, as a consequence of the accumulation, can continue on a low
interest rate trajectory, which its on right now, and finance this huge
savings gap.
COYLE: This is in stark contrast to the healthy
state in which Laura Tyson and Bill Clinton left the American
governments finances, with a very large budget surplus. Now the rest of us
are financing a huge American deficit - and for the privilege were paying
much more for our own mortgages and business loans, because global
interest rates are higher than they might otherwise be. In theory, the more
governments borrow, the smaller the pool of funds available for private
sector borrowers and the higher the cost of borrowing for everybody.
America calls the tune in the world economy. But what about the much
smaller British government debt, which is currently 34% of GDP? Is that
pushing up our interest rates too? Not according to Gerald Holtham. Hes
chief investment officer of Morley Fund Management, one of the biggest
investment firms in the City of London.

HOLTHAM:
Our debt ratios around 34. You can
hardly find a country with a lower debt ratio than that and you can hardly
find a country with higher interest rates than that. Most of the Europeans
have got much lower interest rates. The world capital market is one place
government has to do something quite extraordinary to push its own
interest rates out of line with others. And if were going to see a
generalized rise in interest rates around the world, it will be either because
the world economys picking up and short-term interest rates rise or
because theres such a general loss of discipline if you like by global
governments that the government debt to GDP ratio for OECD countries as
a whole goes up. Thats what it would have to take.
COYLE: But if any one country can have
almost no effect on its own interest rates through its own government
borrowing, why on earth are people worrying about the level of
government borrowing at the moment?
HOLTHAM:
Diane, youve got me. I think the real
reason is that there is quite a lot of genuine concern about whether the
increased government expenditure in this country is well spent. I would
assert that if, if those concerns are baseless and that in fact this money is
being well spent, there is no macroeconomic reason why it shouldnt
continue for quite a long time.
ROSEWELL:
What you need is proper procedures
inside government to decide what sort of investments are valuable and
what are not.
COYLE: Economist Bridget Rosewell is
advising the Mayor of London on how to do just that.
ROSEWELL:
An example, something that Im
concerned in a lot at the moment, is the Cross Rail project for London
Transport which would relieve pressure on Londons transport system,
which is creaking and groaning at the seams, and which will generate
benefits, including more jobs, more tax revenues for government. If you
do any of the calculations, you would say that it has if you like a financial
return which will over a long period pay for itself just in tax revenue
terms.
COYLE: So youre saying were just not very
good at figuring out what the benefits are, what the value for money is in
what the government invests in?
ROSEWELL:
I think thats right. I think that were
not very good at thinking about what is a benefit and how we would
measure it in monetary terms, in tax revenue terms. I think were not very
good at measuring what if you like a non-monetary output is likely to be
like the output of the education system, for example, or indeed the health
system.
COYLE: The golden rule, remember, allows
the government to borrow money in order to invest. But it doesnt set the
criteria for deciding whether or not any particular investment will be good
value for money or tell us which investments to choose. So is there much
point to having the golden rule? Robert Chote is the director of the
Institute for Fiscal Studies.
CHOTE: If you have an investment that future
generations are going to benefit from, then its reasonable that they should
pay some of the cost; and one of the ways you might do that is for the

government to invest, to take on debt and then for future generations to


help repay it. And so the golden rule is about basically about fairness.
But the government judges that by saying: Is this particular piece of
spending, does it count as an investment according to the national
accounts, those are international accounting standards. So, for example,
under those rules the millennium dome is an investment but spending on
teachers pay isnt. But its not clear that if you think whats going to
benefit future generations more, that teachers pay might well be more
beneficial than something like the millennium dome or paying for new
facilities to host the Olympics. And so in that sense, its only at best a
good rule of thumb, a reasonable guide, and its not an optimal one.
COYLE: It certainly seems fair to make our
children pay something towards the benefits theyll get from money the
government spends today. But what about the Chancellors second rule,
known as the sustainable investment rule, which limits government
borrowing, even for good investments, so that the national debt never
climbs above 40% of GDP? Whats so magical about that number?
CHOTE: Too much borrowing is when the
financial markets start to get worried about it, so thats a slightly moving
target. Certainly if you look at the amount of debt that governments build
up, that is hard to say whether a particular target and the government here
says that debt shouldnt rise above 40% of national income theres no
good underlying, theoretical reason why it should be 40%, 50%, 30%. You
can look internationally, you can look historically and say: Well, have
countries tended to get into trouble at that sort of level?
And they havent
really.
COYLE: Still, our rules are more flexible than a
strict ceiling applied each year, like the Maastricht 3% of GDP limit.
France and Germany have both breached that level in the past year. And
whats more, theyve decided they wont even try to get back below it for
the forseeable future. Is there any point in having such a tough rule if its
not enforced? Katinka Barysch is chief economist at the Centre for
European Reform.
BARYSCH:
There are countries in the Eurozone
that have much higher public debt and that have a history of instability in
their public finances. And obviously were getting new members into the
European Union and eventually into the Eurozone. Thats why we need
the rules. And it was the Germans and the French, to a lesser extent, who
initially wanted the rules to impose discipline on the other countries, not so
much on themselves.
COYLE: Its ironic indeed that most of the
smaller EU countries have stuck to the Maastricht rules, while Germany
and France have failed to live up to the fiscal discipline which they helped
formalise for the Eurozone in whats known as the stability and growth
pact. The excuse is that economic growth has recently been so weak that it
would have been the wrong time to reduce budget deficits.
BARYSCH:
They should have reduced their
deficits when the going was still good. Until about three, four years ago,
we actually had fairly good growth rates in the European Union and these
countries probably should have used that time to tighten the purse and start
saving for a rainy day. Thats exactly what the stability and growth pact
says you should balance the budget if the going is good. And Germany
and France and also Italy did not do that. They didnt tighten the purse
strings. They continued borrowing and spending, and then when the
economy went down and these economies came close or actually went into
recession, their deficits were already quite close to 3%, so then they had no

room for manoeuvre left.

And thats why they

then found themselves in a position to have to tighten fiscal policy at a time


when the economy was weak, which is not very good for growth.
COYLE: While theyve only got themselves to
blame, its easy to see why the French and German governments decided to
suspend the Maastricht rule. The alternative would have meant raising
taxes or cutting public spending at a time when that was the last thing their
economies needed. It obviously makes sense to avoid reducing government
borrowing if thats going to make a recession even worse. But does that
mean governments should go further and deliberately use fiscal policy to
boost a weak economy or cool down one thats overheating? Not often,
according to Bridget Rosewell.
ROSEWELL:
Fiscal policys hard to use for finetuning; you cant make sort of little tiny adjustments in taxes as you can in
interest rates. You have to change systems to collect taxes. And say you
change the VAT rate, everybodys got to recalculate and theres the huge
administrative burden of all of that. On the other hand, there are certainly
circumstances where you might well say that an imbalance is such that you
would want to put some fiscal policy into the mix, that there isnt enough
movement in monetary policy. Particularly if we have low and relatively
stable interest rates because inflation is very low, you might get less ability
to move that. So that in Japan, for example, where theyve had a long
period of very low growth, its been quite hard to use enough monetary
policy because interest rates are practically zero in any case, and there
fiscal stimulus might become important. But its more a sort of its the
big stick when youve run out of everything else really, rather than its a
regular tool.
COYLE: Few economists would disagree. In
the past it was common for governments to try to fine-tune economic
growth by adjusting the level of their own borrowing so common it had a
name, Keynesianism, after the famous economist John Maynard Keynes.
But the administrative burden wasnt the only difficulty. As Katinka
Barysch reminds us, Keynesian fiscal management only ever worked in
one direction, and that was inflationary.
BARYSCH:
The other problem that we found with
Keynsianism was that politicians have a very short horizon which normally
lasts until the next election, so they couldnt be relied upon to then make
savings when growth picked up again. There is a case to be made to bind
politicians hands because our experience seems to be that if we just leave
budgetary spending to the political cycle, it tends to go off the rails. So we
have rather good experience in some countries with national fiscal rules,
the politicians are binding their own hands, and if their voters come along
and their trade unions and their interest groups and say we want more
money for this, that and the other, they can say: Well, I dont have that
money, my hands are tied, we have fiscal rules, I need to stick to them.
And on a national level, that seems to work quite well. And in theory it
should work even better at the European level where there is a certain
amount of peer pressure and surveillance between the countries.
COYLE: But the trouble is, it hasnt worked at
the European level. The politicians have had their way.
BARYSCH:
We dont actually quite know whether
it has worked or not. It might well be that if it wasnt for the stability and
growth pact, the German and the French government budget deficits might
actually be much larger than they are at the moment. Theyre not huge
theyre between 3 and 4% of GDP. Thats actually not massive. There is a

case to be made that the rules have actually worked to a certain extent; that
the governments would have borrowed even more had it not been for the
pressure that the other European countries have put on them.
COYLE: A sobering thought for French and
German taxpayers. But theres a real dilemma here. Whatever the rules,
whether the strict European version or the flexible British one, government
borrowing is creeping up in most of the G7 countries. Does this tell us that
fiscal policy should be taken out of the political arena and handed over to
independent experts? After all, this Governments decision to give the
Bank of England the power to set interest rates has been judged a huge
success.
BUDD:
The government cant possibly
delegate the task of raising and spending money. That more or less defines
a government. The best it can do is perhaps delegate the authentication of
the numbers its producing.
COYLE: Sir Alan Budd.
BUDD:
I sometimes feel it would be a
reasonable rule that the governments finances are only sound if external
forecasts say that they are sound. At the moment we are relying on the
governments own forecasts of its own financial future, but it is inherently
worrying if the finances only look right on the governments forecasts
which turn out to be more optimistic than everybody else. So the question
is whether there is some way of setting up an authoritative body to look at
those forecasts or even produce its own forecasts, and its against those
forecasts that the government should be judged.
COYLE: The Treasurys forecasts have tended
to be more optimistic than anybody elses. In the 1980s and early 90s this
optimism proved to be unjustified, but since then its usually turned out to
be more accurate. Ed Balls, as Chief Economic Adviser to the Treasury,
now does the job Alan Budd once did for Kenneth Clarke. He believes that
the Treasury has got its sums more or less right, and he doesnt like the
idea of delegating fiscal decisions to an outside body.
BALLS: We judged that it would not be right
for our political and constitutional system to have independent fiscal policy
decisions. Those decisions have got to be made by ministers and
accountable to Parliament. But what we do think is that accountability
needs to be real and that depends upon the widest degree of public debate
and scrutiny. We have actively promoted that, it happens all the time.
Now should we have an independent fiscal committee scrutinizing fiscal
policy? I dont think so. Ken Clarke in 1993 established his panel of wise
men to comment on his job on running the economy. What he proved with
his wise men was that they could never, ever between themselves agree. It
meant that there was less degree of scrutiny and more confusion.
COYLE: It must be right that in the end the
buck stops with the elected politicians when it comes to how much of our
money theyre going to deduct in tax and how theyre going to spend it. Its
up to us as voters to decide whether we prefer the newly-announced
Conservative plans to cut spending and taxes, or the current governments
emphasis on investing more in public services. But its important that we
dont fool ourselves that more borrowing wont have to be paid for later by
higher taxes. Sir Alan Budd.
BUDD:
If politicians pretend that public
spending can be paid for other than by the taxpayer, they are deceiving the
public and its their responsibility to explain to the general public that

every penny of public expenditure has to be paid for sooner or later. The
cost of doing so isnt in any sense removed by borrowing; its simply
postponed. And of course in some sense theres not the slightest difference
between borrowing and taxation except that if you borrow theres an
interest cost on top of all that. If the governments finances are becoming
dangerous in the sense that people dont believe that it can pay for the
amount of borrowing that its currently undertaking or wont be prepared to
raise the taxes to do so, then to me the answer is that it has to raise the
taxes.
COYLE: Excessive borrowing only delays
higher taxes, because the interest has to be paid on government debt. Its
just the same as when we as consumers buy more than we can afford on
credit - and end up with an even bigger bill because of the interest. If we
want more spending on public services, wouldnt it be better to pay for
them through higher taxes now, rather than putting off the day of
reckoning? Ed Balls, once a political adviser to Gordon Brown and now a
Treasury civil servant.
BALLS: We I think have been honest about the
choices the country has faced. But in order to deliver the kind of
investment people want to see in the health service, we also in the 2002
budget raised taxes, raised national insurance in order to invest in health.
And if you look today at the surveys of public opinion, I would say that the
large majority of the public support the need for investment in public
services and recognize that you have to pay for that investment. You cant
get something for nothing.
COYLE: Heres a hint that Gordon Brown will
raise taxes by as much as it takes to stick to his rules and still pay for his
promises on public services. Borrowing more instead would only give us
an illusion of being able to afford more public spending. The reason we
need the golden rule is that it stops the government mortgaging the future.
So lets hope the Chancellor stays just as prudent as he started out.
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