Economics

Why the Fiscal Charter is flawed

If Labour can quell the in-fighting they could make a strong case against the government's fiscal policy

October 14, 2015
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The August labour market

The government has another reason to boast about the economy today. After a little angst about what was happening in the labour market earlier in the year, the data for the three months to August was almost perfect. The level of employment rose 140,000 to a record 31.1m, meaning that the employment rate also hit a record 73.6 per cent. Though there are definitional issues, this is markedly higher than in most EU countries, and in sharp contrast to what is happening in the US. The rise in employment spanned both full-time and part-time workers, though the number of the former continued to trend higher. Rising employment was focused mainly on employees as opposed to self-employment, and on those born outside the UK (especially the EU) as opposed to those born in the UK.

Unemployment in the three months to August fell 79,000 to 1.77 m, so that the unemployment rate dropped to 5.4 per cent, or, according to separate ONS estimates to 5.3 per cent in the month of August. The number of long-term unemployed continued to fall. Unemployment for 18-24 year olds is 13.3 per cent, compared with 20 percent a few years ago, while for prime working age people of 35-49 years, it is a mere 3.5 per cent.

The headline numbers on earnings look good. Average weekly pay in the quarter to August was up 3 per cent, which represents a significant gain in real pay when you consider that measured inflation is just below zero. But there are a couple of things that merit watching. Regular pay, excluding bonuses, was up 2.5 per cent, compared with 2.9 per cent in July, and private sector regular pay slipped from 3.4 per cent to 2.9 per cent. Assuming oil prices don’t suffer another collapse, last year’s plunge is going to drop out of the index between September and January, so that reported inflation will move up this winter. If the labour market boast is to stand its ground, pay growth will have to move up to match, otherwise the economy may soften as a result, and the government’s opponents will capitalise on a renewed decline in real wages. The government will hope that the tight labour market is as tight as it looks: the Bank of England’s Agents report that the economy faces the highest level of recruitment difficulties since 2005. Traditionally, this has lead average earnings upwards.

The not so august Fiscal Charter

Tonight’s parliamentary business on the Fiscal Charter promises to be rather feisty. Shadow Chancellor John McDonnell has now famously gone back on his commitment to the Labour Party conference two weeks ago to back the charter—albeit through other means than the government proposes—and will now oppose it. McDonnell will press Labour’s claim to be the principal anti-austerity party and articulate his own fiscal strategy. The government will doubtless ridicule Labour’s about-turn, and try and persuade that it is after all, a deficit-denial party. This relatively simple narrative misses important points.

The government’s fiscal charter comes across as sensible house-keeping, but the state isn’t a household. There are sound reasons why the government should aim for a balanced budget or a surplus over the medium-term and during “good” economic times, which the Office For Budget Responsibility can define and articulate. But the government’s charter is wooly about the circumstances under which that target should be allowed to slip, be delayed, or even abandoned temporarily in favour of running a deficit. We could even run small deficits, if needs be, and still see public debt decline as a share of GDP, provided that economic growth exceeds the level of gilt yields. We could, some say should, also allow for extenuating circumstances. We may decide we want a programme of targeted public investment that the private sector can’t or won’t finance. We may one day even need to boost defence spending if fractious geopolitics should so warrant.

Labour’s about-turn on the charter, to which some of the party’s new economic advisers have given their immediate and unequivocal blessing, comes across as a mea culpa and a return to responsible opposition. There is, after all, a bona fide case for pointing out the Chancellor’s charter flaws and proposing something quite different. But the tired bleating of some of the Party’s new advisers that whatever the error at the party conference, “we are on the right road now”, doesn't quite cut the mustard. We shouldn’t assume that this hand-brake turn was down to oversight and that it’s time to move on quickly. It raises important questions about competence and trust, and it prompts us to ask what the Party actually believes in, rather than what it’s opposed to. It is early days for the new leadership and there may be much that hasn’t been properly developed as strategy yet. But we can be forgiven for thinking that the broad outlines of policies that embrace an overturn of current fiscal policy, vastly exaggerated claims for tax policy, renationalisation, and an implicit ending of the Bank of England’s independence are as much about Keynes as the fiscal charter is about Milton Friedman.