Sajid Javid: the electoral chancellor

Sajid Javid’s speech to the Conservative Party conference this afternoon was more notable for what he did not say than what he did say, other than the crowd-pleasing plan to push up the national living wage. The chancellor’s upbeat message reflected the theme of an electioneering conference: let’s get Brexit done and spend lots more. Nowhere was there a recognition that spending more by borrowing more will mean breaking the government’s fiscal rules, even if a disastrous no-deal departure from the EU can be avoided.

Javid promised lots of investment to upgrade Britain’s shabby infrastructure. In fact, much of this had already been earmarked by his predecessor. Philip Hammond announced in his budget last October the “biggest ever strategic roads investment package,” committing to spend £25.3bn on this strategy between 2020 and 2025.

But whether the pledges are new or old, Javid is clearly under immense pressure to find the money for Boris Johnson’s reinvention of the Conservative Party as a big spender. Since the prime minister is also keen on lower taxes that must mean higher borrowing. The chancellor appears trapped, since beyond a certain limit that will breach the fiscal rules.

At present the government has an objective to balance the budget by the mid-2020s. More immediately and relevantly its main rule is that borrowing (adjusted for the economic cycle) should be below 2 per cent of GDP in 2020-21, the financial year starting next April, together with a supplementary aim for net debt to be falling as a share of GDP in that year. There is also a more distant target for a cap on welfare spending.

In March the independent Office for Budget Responsibility forecast that the government was on track to pass its main rule with a comfortable margin. That “headroom” for extra borrowing in 2020-21 amounted to £26.6bn. However, the OBR warned that changes in the way in which student loans are treated in the public finances would reduce the margin to £15bn.

On the face of it, Javid’s spending statement earlier this month managed to remain within that limit since he raised expenditure in the next financial year by £13.4bn above previous plans. Even so, his readiness to splash out on the basis of an obviously out-of-date forecast was hardly the act of a cautious chancellor. Just how incautious it was became clear last week.

New official figures, attracting little attention at the time because they were announced on the same day as the Supreme Court’s judgment on prorogation, rewrote the public finances—for the worse. At a stroke they increased the deficit for the last financial year (ending in March 2019) from the previous estimate of £23.6bn to £41.4bn, an increase of £17.8bn. Of this at least £15bn a year will persist according to the OBR; it may well be between £16bn and £17bn.

The higher borrowing recorded for 2018-19 arises mainly from the new accounting approach for student loans, which has now been incorporated in the public finances. This pushed up borrowing by £12.4bn in 2018-19, almost £2bn more than the OBR had estimated for that year in March. On top of that, the revisions included the correction of an error by HMRC which had overstated corporation tax receipts by £2.6bn while a new treatment of public sector pensions contributed a further £1.3bn.

On the face of it these revisions slash the supposed headroom for higher borrowing in 2020-21 to around £10bn. But the position is worse still because the deficit this year, which was forecast to rise temporarily anyway, has been running much higher than expected. Indeed, just five months into the financial year it is almost £7bn higher than in the same period in 2018-19, a rise of 28 per cent.

Altogether, the statistical revisions and this year’s adverse borrowing trend have removed the headroom in 2020-21 that Javid was relying upon. If the pattern of the first five months holds for the rest of this financial year, the deficit will be 2.4 per cent of GDP, up from 1.9 per cent in 2018-19 (previously recorded as just 1.1 per cent). Including the extra spending that the chancellor announced on 4^th September, the deficit in the critical year of 2020-21 looks set to be around 2.5 per cent of GDP, breaching the main rule.

That leaves Javid with only one option: he will have to change the fiscal rules so that he won’t break them. There is nothing new in this. When Hammond replaced George Osborne as chancellor in 2016 he junked his predecessor’s goal of achieving a budget surplus by 2019-20 and then maintaining it. The OBR commented at the time that the government was on course to meet all three of the new fiscal targets he had set while missing all three of the ones he had dropped. The effect was to allow higher borrowing of up to 2.5 per cent of GDP in 2020-21 (the difference between Osborne’s planned surplus of 0.5 per cent of GDP and Hammond’s borrowing cap of 2 per cent).

Javid will now loosen the rules still further to allow still more borrowing. One politically tempting if specious approach might be to focus on a decline in net debt as a share of GDP, at least in the near future. This will be easy to achieve over the next two financial years since it will be falling then anyway as banks repay special loans made by the Bank of England, causing its associated liabilities—which are counted as public debt—to shrink.

Whatever the precise way that Javid does relax the rules, he can exploit the fact that the financial markets have themselves become far more lenient, with long-term borrowing rates at record lows. The whole elaborate apparatus of fiscal rules was set up to placate financial markets in the era of bond vigilantes who struck fear into the hearts of finance ministers. By creating these self-imposed constraints they hoped to win credibility and thus avoid ambushes in the markets. But in the new era when the vigilantes have limped off the field, chancellors can take more risks. And that is exactly what Javid will do—though none of this will count for much in the fiscal calamity of a no-deal Brexit.