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Loosening the Purse Strings: Is the Treasury obstructing investment?

(Credit: Jeanette Teare / Alamy Stock Photo)

7 min read

With Britain in a rut of failing services and economic stagnation, advocates for higher public spending accuse the Treasury of obstructing investment that could have positive effects. Do they have a point? Chaminda Jayanetti reports

The chaotic tenure in No 10 and 11 Downing Street of Liz Truss and Kwasi Kwarteng has bolstered advocates of a cautious approach long derided as the “dead hand” of the Treasury.

Amid crashing markets and a plummeting pound, the pair were accused of treating the Treasury and Office for Budget Responsibility (OBR) with contempt, with a cavalier approach to unfunded tax cuts, at a time of rising interest rates and inflation.

But now the “grownups” are back in charge in the form of Rishi Sunak and Jeremy Hunt, might these key financial institutions continue to act as a “defensive and defeatist” drag, as the economic commentator Martin Wolf once described the Treasury? Do they underestimate potential returns from public spending? And what might those returns be anyway?

The Institute for Public Policy Research (IPPR) think tank recently published a report calling for more state-funded childcare to increase parental employment rates and improve prospects for children in poorer families.

The IPPR modelled the impact of expanding childcare provision by calculating what would happen if the employment rate of mothers of preschool children matched the higher employment rate of mothers of older children – a predicted benefit of subsidised childcare.

“We looked at moving mothers who are currently out of paid work into part time work, those that are currently on part time hours up to something closer to full time hours, and we looked at what impact that would have across the picture. And we saw quite a significant reduction in benefits spending,” says the IPPR’s Rachel Statham, a co-author of the report.

Of the roughly £15bn total annual cost of the IPPR’s plans, the researchers estimate around £8bn could be recouped through lower benefit spending, increased tax receipts resulting from higher employment levels, and VAT revenues from parents spending their higher employment income.

Adult care is another area where higher spending could bring some partial fiscal returns. The Women’s Budget Group (WBG) has long advocated higher spending on “social infrastructure”, such as adult care and childcare, on the basis that it creates more jobs per pound – and thus more tax revenue – than investment in capital infrastructure such as transport and construction.

During the summer of 2020, the WBG published a report arguing: “The net costs of any programme of investment in care would fall over time as future demand is reduced by preventative care, reduced public spending is needed in other areas to cope with the effects of inadequate care and government revenue grows due to the increased productivity of a healthier, better cared-for population.”

“The failure to develop a good social care system has resulted in huge costs for our health system,” says economist Sue Himmelweit, who has led some of the WBG’s work in this area. “It will have produced costs for people who’ve needed residential care in the future rather than domiciliary care because they haven’t been well enough looked after when their needs were low – their needs get higher.”

But do our political parties and key financial institutions pay enough attention to the potential fiscal benefits of public service investment?

According to a former senior political adviser who covered the Treasury brief, political parties are wary of producing policy costings out of fear of being shot down by their opponents if their figures conflict with those from the Treasury or OBR. Instead, parties try as far as possible to draw on Treasury and OBR costings to minimise political risk.

Political parties are wary of producing policy costings

“OBR forecasts are based on a macro-model of the whole economy,” the former adviser says. “With, yes, loads of assumptions built in about what spending on X does to the economy. For example, they have an estimate of the multiplier effect of spending on infrastructure in the short term, or the long term, or of cash transfers to better off or worse off people. They have estimates of the impact of tax v spending.

“These are all fairly standard economic tools – and economists can all reasonably disagree with those assumptions – but they are fairly well understood assumptions.”

Economist and former civil servant Jonathan Portes, a frequent critic of austerity, says the Treasury will only accept claims of purported knock-on fiscal benefits of public spending or tax cuts if there is solid evidence for them – which is hard to come by.

“It is all very well going to the Treasury and saying: ‘if you invest this much in education, then we’ll have higher productivity in 10 years’ time’,” says Portes. “That’s essentially a political, rhetorical argument – the Treasury is not going to score that. Doesn’t mean that Treasury ministers or the process ignores it, but it’s not going to be written down and scored in terms of hard numbers. That’s for good reasons – the uncertainties are just too great.

“If you can show a piece of hard evaluation evidence that says, ‘if you do this on housing, then you can reduce homelessness spending by this much’ – the Treasury will score that. But that’s really, really difficult, so it doesn’t happen very often.”

“The reality is the Treasury runs the numbers as best as they can – and is probably quite cautious because ultimately it’s their job to be cautious,” adds the former senior political adviser. “So there can of course be quibbles round the edges about assumptions. But the big picture is the ‘benefits’ people are keen to shout about aren’t always fiscal benefits. And it’s the Treasury’s job to be ruthless about pointing that out.”

Those advocating higher public spending recognise the challenges. “You can talk about the direct investment impacts of public spending – particularly when you’re looking at major services like healthcare services – direct employment effects, direct economic activity effects, direct capital investment – and that’s accounted for quite straightforwardly through our GDP measures,” says the IPPR’s Statham.

The ‘benefits’ people are keen to shout about aren’t always fiscal

“And then when you’re thinking a bit more broadly about what that means for local economies, what that means for local jobs, what that means for local labour markets – that’s where we don’t have as clear a picture.”

The IPPR’s figures for the benefits to the Treasury of expanded childcare include £1.5bn in higher VAT revenues from parents spending 100 per cent of their increased employment income on goods and services – a percentage Statham admits is “probably on the generous side”, although low-income parents are likelier to spend additional income than save it given children’s needs and tight household budgets.

As Portes says: “The bar – and I think quite reasonably – is high. If you really want a big national childcare strategy that costs £7bn or £10bn, then ultimately you do have to win the political argument –  this is an investment in our future and it’s worth doing, and we’re going to find money for it out of tax revenue or we’re going to expand the deficit for it, rather than trying to justify it by making up some numbers which are going to be wrong anyway.”

Ultimately these questions are intensely political. But economic analyses feed into politics. When the long-term effects of public spending or tax cuts are so hard to accurately quantify, they veer into guesswork that undermines the credibility of Treasury and OBR forecasts.

However, if economic institutions cannot account for the broader impacts of fiscal decisions – on people’s health, on child development, on labour market participation, on local economies – those impacts risk becoming invisible to policymaking.

“It might be difficult to estimate,” says Himmelweit. “But that doesn’t mean the best estimate is zero.”

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