Government's Fiscal Rules

Part of Opposition Day — [18th Allotted Day] – in the House of Commons at 4:56 pm on 7th October 2008.

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Photo of Peter Viggers Peter Viggers Conservative, Gosport 4:56 pm, 7th October 2008

I have never risen to speak with more diffidence. This situation is extremely difficult, and I am anxious not to make it any worse. I went through the secondary banking crisis in the 1970s as a director of a merchant bank, and I am now on the Treasury Committee, having previously been a Parliamentary Private Secretary at the Treasury. Given that background, I want to make a contribution, and I hope that some of what I have to say is of some use or value.

First, we must look at the background. The present Prime Minister, as Chancellor of the Exchequer, got three things right in 1997: first, we did not join the euro; secondly, he created the Monetary Policy Committee; and, thirdly, he decided to follow for some years the spending plans of my right hon. and learned Friend Mr. Clarke, the previous Chancellor of the Exchequer. He also introduced the fiscal rules.

The first fiscal rule is the golden rule that, over the economic cycle, the Government will borrow only to invest and not to fund current spending. The second is the sustainable investment rule, which states that public sector debt must be kept at a stable and prudent level and that, in most circumstances, net debt should be maintained below 40 per cent. of gross domestic product over the economic cycle.

When I made my maiden speech in the House in the spring of 1974, I urged something even more extreme. I was a former director of an oil company with interests in the oil industry, and I proposed that the oil and gas reserves in the North sea were minerals and therefore a capital investment, and that any depletion of a capital investment should be made only if it were matched by spending. In other words, I argued that we should regard the oil and gas money not as revenue but as a depletion of capital. To that extent, I was even drier than the two fiscal rules introduced by the Chancellor of the Exchequer in 1997.

There were two bad judgments in 1997. The first was the creation of the tripartite arrangements between the Treasury, the Financial Services Authority and the Bank of England, which were insufficiently clear and allowed the banking crisis to come upon us without sufficient recognition by the FSA. The removal of the supervisory role from the Bank of England was, in my opinion, a mistake. Through the Treasury Committee, I have urged that we should try to distinguish between the regulation of banks, which is the responsibility of the FSA, and the supervision of banks, which in my opinion should be the responsibility of the Bank of England, because only the Bank of England has the necessary close, hands-on ability to deal with banking problems. We are talking about the movement of the Governor of the Bank of England's eyebrows, and the quiet persuasion that the Bank is capable of exercising.

The second bad decision taken in 1997 was the tax of a net £3 billion on pension funds imposed by the Chancellor of the Exchequer. Some of my colleagues call it a £5 billion impost, but in fact it was a £3 billion impost, and it was not the main cause of the problem in the pensions industry. In order, the causes were, first, increased longevity, which was not recognised by the actuarial profession, secondly, stock exchange weakness and, thirdly, the tax imposed by the Chancellor of the Exchequer. That led, however, to the closing of many final salary schemes, which in turn led to many people thinking that instead of saving through a pension, they could save through house values. They looked to house prices as a store of money, which, in due course, they could rely on to fund their standard of living in retirement. I am afraid that that will prove a very serious problem, because people in their 40s and 50s cannot begin to hope for the standard of living in retirement that many pensioners currently enjoy.

Those were the mistakes of 1997, but things really began to go wrong in 2000, when the Chancellor of the Exchequer gave up on prudence and loosened the spending taps. Spending was up, and much of it was financed through stealth taxes—the definition of which is that they are concealed from individuals, who are not meant to notice them—which have a distorting effect on the economy. The weakness that was building up was masked by an extraordinary world tailwind of prosperity caused by globalisation. The prosperity of the Asian tiger economies, followed by the so-called BRIC economies—Brazil, Russia, India and China—combined with the benefits of globalisation, led to the symptoms of our problems being masked, and we did not realise how bad the situation was becoming.

Even so, it became necessary for the Government to fudge the figures on the fiscal rules, which depend on the economic cycle. In July 2005, we were told that the cycle began in 1997, not 1999. In 2005, in the pre-Budget report, we were told that the cycle would end in 2008-09, not 2006. Later, in the 2006 pre-Budget report, we were told that the end date would be 2007, not 2008-09.

The fiscal rules are intended to take into account the difference between generations. In the 1999 Budget, I think, the Chancellor defined what that meant: the Government do not pass on the costs of services consumed today to the taxpayers of the future—each generation is expected to meet the current cost of the public services from which they benefit. That is a laudable intention, but it does not work, and it is distorted by two factors. First, private finance initiatives are not taken into account in expenditure, and expenditure is treated as coming from future revenue, not current capital. Secondly, public sector pensions are largely unfunded, and that huge liability is also regarded as a duty of future revenue streams. In addition, Northern Rock is not included in public debt, and personal household debt in this country is 177 per cent. of disposable income—the highest in the world—which shows that there are problems to come.

What do we do now? I am not an enthusiast for Government initiatives, but the situation surely needs a lead. My first principle is that this is no time for laissez-faire. My second principle is that initiatives must be on an international basis, so I welcome the international meetings taking place today. It is obvious that we cannot find our way out of this by ourselves, especially as the economy in this country is in a less good position to cope with the problems than those of many other countries. Therefore, we must have international co-operation.

My third principle derives from what happened with Lloyd's of London, which I think is the nearest analogue to the present situation. I was very much involved in the Lloyd's of London rescue—I was one of the four members of the Lloyd's audit committee. What we did then was draw a line between bad and good assets, and I think that, somehow or other, the same needs to be done now. That is why I am so opposed to the Paulson plan in the United States. Henry Paulson proposed a $700 billion fund to buy toxic assets at more than their market value, thus pumping money into the banking system. I think that that is completely wrong, because it goes against the principle of moral hazard and also leads to the impression that there is a rescue fund of $700 billion.

During the discussions on the Paulson plan, we heard many Congressmen say that they wanted some of the $700 billion for people in their constituencies. That is completely the wrong attitude. There is not a fund to be shared out; rather, there is pain to be shared. We must find ways of coming together and establishing how that pain can best be shared between those who can afford to share it and those who should bear it, because my next principle is that we must respect the importance of moral hazard—those who have taken the risk must bear a proportionately higher share of the pain.

My fifth principle is that, as we all know, borrowing short and lending long is sustainable only if there is confidence. That confidence must be restored, and I see no reason why it should not be restored. There is much that is good in the economy—we must bear in mind that even Hitler could not stop the daffodils growing. What we must do, having cauterised the toxic elements, is move on, restore confidence and work with the good elements in the economy.

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Nigel Steward
Posted on 8 Oct 2008 12:17 pm (Report this annotation)

Good points Sir Peter.

NJSS