Memos to Ministers: The Treasury

Labour’s five years in opposition culminated in an election manifesto which married fiscal discipline with a programme for social and economic renewal. The document only contained fully costed pledges, but it also promised big solutions on issues from inequality to public services to the workplace. It is a fine balance which the role of the Treasury will do much to determine.

As if anybody needed reminding, economic credibility is difficult to establish and easy to lose, so the discipline Labour showed in opposition will need to continue. But this doesn’t have to mean business as usual. One of the Treasury’s first priorities will be to set about preparing for a comprehensive spending review to determine how money is spent after 2015-16 – so use this opportunity to showcase a new approach.

The final report of the Fabian Commission on Future Spending Choices provides a template for a new cycle of spending reviews which are more bottom up, participative and democratic in design. The first job will be to align any new cycle with the realities of the Fixed Term Parliaments Act. A definitive five year settlement is one possibility. However, there is still a high degree of fiscal uncertainty. So it’s preferable for a spending review to set out definitive plans for three years (2016-17 to 2018-19) with a rolling capital investment budget over a five year period so that major investment projects can be planned in the long term.

Next, when it comes to allocating expenditure between different departments a ‘who gets what’ strategy will lead to poor decision making and distract attention from the outcomes government wants to achieve. The 2010 Spending Review minimised collaboration in this way and while it led to speedy departmental settlements, some major strategic issues went overlooked. The experience suggests it would be better leave sufficient time in the process for collaboration between ministers so that departmental spending, investment, social security and non-fiscal policy can be considered side by side.

Compositional shifts in the public finances have made this approach more pressing. Soon spending on social security and debt interest will overtake departmental spending as a share of total expenditure. Combined with the interplay between protected and non-protected spending this means the state’s resources are becoming increasingly focused on pensions and healthcare. As any Labour chancellor would agree, these are very important spending commitments. But it is also true that tilting the balance of public spending too far away from long term investment stores up economic problems for the future. It is something an incoming Chancellor will want to take a view on and their thinking will be assisted by reading the Commission’s work.

This approach will also aid clear thinking about the many other items buried in the Chancellor’s red box. One is how to approach the job of deficit reduction and here there are clear lessons from the 2010-15 parliament.

The coalition paid a high price for treating deficit reduction only as a fiscal question when it is also one of growth and productivity. Crude axe-wielding means GDP per capita is still 16 per cent below where it would have been on pre-crisis trends and productivity is 15 per cent below the pre-crisis trend. Income tax receipts are around £30bn lower than forecast in 2010.

Cast your mind back to the Office for Budget Responsibility’s alternative productivity scenarios published last December. They showed that if productivity per hour returned to the levels seen in the 1970s and 80s the current budget would reach a balance next year and continue to strengthen throughout the remaining years of the parliament. There is a huge prize for improving the UK’s wider macroeconomic position.

The Fabian Society’s 2014 report, Measure for Measure, outlined a suite of indicators which will help the Treasury measure this performance. It argued that the government should augment measures of GDP growth with an alternative indicator of economic progress, measured using median housing income. The Labour party adopted the principle in its proposals for a ‘Living Standards Index’ and now thought needs to be given to what this means for the business of the Treasury and government as a whole.

Some of this thinking will run counter to the orthodoxies of the ‘Treasury view’. And there are many who question whether Treasury dirigisme runs counter to the decentralising current of a lot of existing Labour party policy. This probably doesn’t mean going back to a split institution modelled on the Wilson-era Department for Economic Affairs, as some have suggested. The Treasury will remain a powerful institution, but the direction of travel means an incoming Chancellor should be prepared to give some of this power away. Whatever happens, it will be better to prepare for all eventualities by refreshing the Summer 2014 edition of the Fabian Review which was dedicated to this question.

None of this will be easy. Poor decision making since 2010 means there is still a high level of uncertainty, both on the fiscal side and in the wider economy as a whole. No Chancellor which has to make difficult spending decisions can be universally popular. But it is worth bearing in mind King James I’s observation: ‘All Treasurers, if they do good service to their masters, must be generally hated’.