MNI INTERVIEW: Ditch UK Debt Rule, But Borrow For Investment

MNI (LONDON) - The new UK government can and should aim to balance the current budget and preferably move into surplus, squeeze consumption through higher taxation and raise debt issuance to boost public investment, Dimitri Zenghelis, a former top Treasury economist, told MNI, although he accepted early signs suggest such a strategy is not imminent.

Zenghelis is a co-author of papers with John van Reenen and Anna Valero, both reportedly set to be leading economic advisors to Chancellor of the Exchequer Rachel Reeves, the product of research that has consistently raised the need to address the UK economy’s "chronic underinvestment”.

One recommendation in the papers published by the LSE-based Centre of Economic Performance (CEP) is the freeing up of fiscal space to borrow-to-invest while fully funding current government spending through taxation. 

CURRENT RULES

Reeves' retention so far of the previous Conservative government's net debt rule, to have debt-to-GDP falling at the end of the full parliamentary term, clashes with a borrow-to-invest strategy.  Zenghelis contends that the net debt rule  should therefore be axed as “not all debt is created equal.”

“It makes no sense to treat debt accrued to finance consumption as the same as debt accrued to finance investment in the asset side of the balance sheet,” he explained. "Can she get away with boosting investment to the requisite levels without loosening the debt rule? Well, in principle, she can, if she makes room ... by cutting current spending or raising taxes, but she would have to do that to such an extent that it would be politically unfeasible," Zenghelis continued.

Reeves has "unnecessarily boxed herself in,” Zenghelis said. “You don't want to accumulate debt on the back of current spending, so all current spending commitments over the cycle should be fully funded.  And she knows that, but she's somehow taken the view that given the politics, the optics of a Labour government, not adjusting the rules might be necessary to boost credibility."

BUDGET

The Chancellor’s maiden budget, scheduled for October 30, could see her tweak the fiscal rules. For example, including the Bank of England in the debt rule would give additional headroom for borrowing while pushing harder on tax rises, having already axed some of the previous government's spending plans.

Some adjustments are likely to take place for the fiscal rules to be met, Zenghelis said, pointing to the fact that “creative accounting” could allow scope for additional borrowing.

“It could be greater use of the public investment banks to get borrowing off the balance sheet, but I think she'll find a way to enable additional borrowing," Zenghelis said.

In a paper with Valero and Van Reenen in February, Zenghelis argued higher taxation could help maintain the macroeconomic balance as, with near full-employment, increased investment would have to displace other spending. 

His preferred option is to "ditch the debt rule, but if anything, double down on your commitment to balance the current budget over the cycle, potentially by erring towards a current surplus.” That, he says, will “create the space in terms of domestic saving to avoid crowding out of private investment and to avoid a further ballooning of our current account deficit."

Additional reporting by Harrison Moore