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The Treasury today: a devalued currency?

It has been the most powerful department on Whitehall for a century, coming back stronger from every crisis. But, argues the former editor of the Financial Times, in the age of populism and Covid-19, the writ of 1 Horse Guards Road isn’t running like it used to
November 30, 2020

In his autobiography The Time of My Life, Denis Healey describes his first impressions of the Treasury upon his appointment as chancellor in 1974. Unaware that he would soon be forced to go cap-in-hand to the IMF, Healey reflected that “the Treasury commands the best brains in a civil service which has no intellectual superior in the world.”

Yet the new chancellor already had doubts about his all-powerful department. “Perhaps it illustrates the familiar problem of the Rolls-Royce in a market dominated by the Volkswagen and the Honda,” he wondered. “Whitehall’s obsession with procedure rather than policy has left it poorly equipped to handle change.”

Nearly half a century on, and several economic crises later, Her Majesty’s Treasury finds itself once again under scrutiny. Covid-19 has traumatised the economy, bankrupting businesses and threatening mass unemployment. Public sector net borrowing has topped £200bn, sums that make the humiliating 1976 IMF bailout look paltry by comparison. Meantime, Brexit, the most serious disruption to UK trading relationships in half a century, looms large.

In his Spending Review unveiled to parliament on 25th November, Rishi Sunak declared a state of economic emergency, a tactic often deployed by previous chancellors to soften up opposition to the inevitable retrenchment to come.  But he is a member of a Boris Johnson-led Conservative Party which appears to have lost its stomach for sound money. The inclination to carry on spending, whether on Covid-19, defence or “levelling up” the north of England compared to the richer south, stems directly from the Prime Minister, never a man for discipline in his private or public life.

A few months ago, Sunak was basking in positive press coverage. Installed in February at 1 Horse Guards Road at the age of 39, just weeks before the pandemic took hold, he had turned on the spigots to support jobs and business. His “Eat Out To Help Out” scheme to help the hospitality sector was wildly popular—at first. He was a star-in-the-making, tipped (dangerously prematurely) as a successor to Boris Johnson. Now Sunak’s glorious summer has turned to a winter of discontent. After much agonising, Johnson ignored Sunak’s warnings about economic damage and sided with the public health experts pressing for a month-long lockdown in England.

The relationship between prime minister and chancellor is, in the words of former cabinet secretary Andrew Turnbull, “the San Andreas fault,” the stress point that can bring everything crashing down. The differences between Sunak and Johnson over Covid-19 have not reached the epic levels of conflict between, say, Margaret Thatcher and Nigel Lawson; or for that matter, Tony Blair and Gordon Brown (which turned more on political rivalry than economic policy). Indeed, Sunak can sometimes argue that what is best for public health is best for the economy.

But the reality is more painful: not only did the Treasury fail to prevent a second lockdown but it has been forced to pay huge sums to mitigate the consequences. For a department whose control of the levers of power is rarely challenged, it has been a chastening experience.

The ghost of Gladstone

George Osborne, who served as chancellor between 2010 and 2016, says the Treasury’s strength lies in its culture of excellence. Only the British intelligence services rate as highly, in his view. (The Foreign Office has lost its edge, he said, perhaps mindful of the department’s challenges to his pro-China tilt.) The Treasury is agile, non-bureaucratic and meritocratic. “It is very much the product of Gladstone,” said Osborne, admiringly.

William Ewart Gladstone, who served four terms as prime minister between 1868-1894, also served four terms as chancellor. The Grand Old Man was not only a great liberal reformer; he also had a strong belief in sound finance. During his tenure, the Treasury emerged as a dominant force on financial matters, in parallel with the establishment of a modern civil service based on merit and open examination. These were the principles recommended by the Northcote-Trevelyan report of 1854, named after a future chancellor (Stafford Northcote) and a serving Treasury permanent secretary (CE Trevelyan).

“The Treasury always had doubts about the Second World War. They thought it was expensive and rather wasteful”

Gladstone’s prudence endured well beyond his time in office. Although balancing the books has waxed and waned as a priority for subsequent governments, in the century since the First World War a sense of crisis about the coffers has rarely been far away. If the developing Empire gave the Foreign Office a natural pre-eminence in Whitehall in the 19th century, in the 20th a recurrent need for belt-tightening did the same for the Treasury. On a long view, the Osborne reign of retrenchment is just one in a run stretching back, via Howe and Healey, all the way to the “Geddes axe” of the 1920s.

But what cemented the Treasury’s dominance was not mere crisis management, but its ability to reinvent itself in a crisis, especially in one that appeared to threaten its position at the heart of government. Nicholas Macpherson, who served as Treasury permanent secretary from 2005-2016, once observed, with some self-irony: “The Treasury always had doubts about the Second World War. They thought it was expensive and rather wasteful.” In wartime (as with coronavirus), the hair shirt only stretches so far. Winston Churchill, for example, banned the chancellor from his war cabinet. But as the national debt rocketed, HMT took the chance to bring former enemies into its camp, and update its own thinking in the process. Keynes, who had spent the interwar years defining himself against the “Treasury view,” was now advocating an anti-inflationary compulsory saving scheme (in How to Pay for the War, 1940). The Treasury invited the great man in, and gave him a desk.

That move ensured the Treasury’s relevance in the postwar era of demand management. Before long it saw off another threat when—with the first Wilson government—the economic fashion turned towards planning. The new prime minister established a new Department of Economic Affairs and tasked it with strategic policy rather than bean-counting; but currency and balance of payments crises soon made bean-counting the fashion again. The Treasury clawed back its power, while the DEA shut its doors just shy of its fifth birthday.

The Treasury has continued to command economic and financial policy ever since, albeit in tandem with the Bank of England which controls monetary policy and supervision of the financial sector. Its position is unique compared to international counterparts. The German finance ministry, for example, shares power with the economics ministry and the chancellor’s office. In the US, the Treasury has to compete with the Office of Management and Budget and the Commerce Department as well as the tax-writing powers of Congress.

It is this unchallenged control of the public purse that is at the roots of the Treasury’s power. Most of the time that discipline has been exerted by how much public money is spent, but when the taps have opened, it has switched focus to how money is spent and to what purpose. The “public service agreements” it wrote during the New Labour years often involved a so-called “dual key,” which required not only the relevant department but also the Treasury to sign off before the responsible ministry could spend its own money.

The state alone can raise money by taxation, and the Treasury remains monopolistic in spirit. With 1,500 employees, it dwarfs the Cabinet Office despite Dominic Cummings’s recruitment drive. It enjoys a pedigree and clarity of mission unmatched in Whitehall, where ministers come and go and departments are constantly changing their names like the new-fangled Department for Business, Energy and Industrial Strategy.

Tunnel vision?

The sustained concentration of power invariably raises the question: how effective is the Treasury in practice? It is sometimes said that HMT knows the price of everything and the value of nothing. At times, like the privatisations of the Thatcher years, it has driven dramatic structural changes; but its default position is to count the pennies with an extraordinary, at times infuriating, attention to financial minutiae.

Twenty-somethings barely out of university will leave no extra mileage on a road or a railway line unchallenged. “When I tried to stop HS2 [the North-South high-speed rail link], someone said that the Treasury [had also been] against the M25,” said Macpherson, but this critic “never came up with the evidence.”

Ken Clarke once likened Treasury discussions to a debate in the senior common room at an Oxbridge college. Confidence is rarely lacking. While the talent pool is not as deep as in the 1960s and 1970s, when a career in the City was less lucrative, there are still plenty of top-notch applicants to HMT. The difficulty comes 10 years on when those same graduates want to climb on the housing ladder, start a family or potentially plan for private education. At that point, other higher-paid options start to look attractive, such as consulting, investment banking or technology ventures.

The Treasury recently opted out of the civil service “fast stream” to manage its own recruitment. Growing its own cadre is a strength in terms of culture. The weakness lies in a narrowness of outlook, said Rachel Lomax, who spent 25 years in senior macroeconomic policy roles at the Treasury, and is widely regarded as the best Treasury permanent secretary who never was.

That same narrowness applied, until recently, to diversity in the workplace. Lomax remembers Healey cooing “Ooh, ladies present!” when she turned up as a young official for meetings. Shriti Vadera, top adviser to Gordon Brown during the financial crisis, was at the time the only woman—apart from the secretaries—granted a seat on the building’s power-ranking second floor, overlooking St James’s Park.

Rachel Lomax, the best Treasury permanent  secretary who never was. Photo: Dennis Brack/Bloomberg via Getty Images Rachel Lomax, the best Treasury permanent secretary who never was. Photo: Dennis Brack/Bloomberg via Getty Images

Rachel Lomax, the best Treasury permanent secretary who never was. Photo: Dennis Brack/Bloomberg via Getty Images

In the last 15 years, thanks to efforts by Permanent Secretary Tom Scholar and his predecessors Gus O’Donnell and Macpherson, women have risen through the ranks. There are four women director generals, the senior rank; other Treasury women have gone on to be permanent secretaries in other departments, with the notable exception of the Treasury itself. The Oxbridge quotient has also diminished, somewhat. (HMT will soon include socioeconomic data in its human resources database and will increase transparency in this area).

In sum, the Treasury’s strengths are its brainpower and esprit de corps. “Treasury man” was once characterised by David Lipsey, in a sympathetic 2000 study of the department, as “highly intelligent,” if “not on the whole intellectual.” Officials are very good when it comes to reacting to crises, surely a bonus in present circumstances; they have long been less sure-footed in anticipating problems. And the lessons of earlier failings remain relevant today.

Cometh the hour, cometh the Treasury

Economic policy in the UK during most of the post-war period was dominated by the fight against inflation and the cycles of “boom and bust.” By the late 1970s, rapidly rising prices had set the monetarists on the march: as ever, the Treasury adjusted, moving seamlessly from a focus on aggregate demand to the various measures of the money supply in the early 1980s. But by the middle of the decade, Nigel Lawson had concluded that the UK’s economy required external discipline, eventually dragging a reluctant Thatcher towards pegging the pound (and at too high a rate) to the Deutschmark through the European Exchange Rate Mechanism (ERM). The move was eventually implemented some months after Lawson had resigned, by the new Chancellor John Major in 1990.

By 1992, the British pound and the Italian lira were under intolerable strain. By September, despite jacking up interest rates, the government could not resist the speculators. The humiliation of Black Wednesday—the ejection of the pound from the ERM—was a devastating intellectual blow to the Treasury, as serious as the sterling crisis of 1976 when the government similarly lost control. But then again, HMT has a record of taking humiliations on the chin and—somehow—emerging stronger. Before 1976, there were the devaluations of 1967, 1949 and 1931, each resisted until the ignominious end, and each followed by retrenchment that put a premium on the number-crunchers. Within weeks of Black Wednesday, officials put together a new economic policy based on inflation targeting. Several years of economic growth followed under Chancellor Ken Clarke.

Another seminal experience was the 2007-2008 global financial crisis. The Treasury was hardly alone in missing the risk to financial stability caused by the preceding credit bubble. Conventional wisdom stated that sophisticated debt instruments such as credit derivatives dispersed risk in the financial system. In fact, the opposite was true. Britain’s banks were more heavily exposed than most, either as borrowers on the wholesale markets (Northern Rock) or giddy players in global investment banking (Royal Bank of Scotland). After a hesitant start, Brown’s leadership at home and abroad, calling for recapitalisation of the banks and a co-ordinated stimulus package for the world economy, was in retrospect his—and the Treasury’s—finest hour.

With hindsight, the expertise eventually shown in handling both the ERM and global financial crisis may have hidden a failure to recognise deeper change in the world economy. Brown’s Treasury was too complacent about the risk to financial stability emanating from “light touch” regulation of the City of London and later too fearful of the political fallout from nationalising the banks. They squandered valuable time with Northern Rock especially in elaborate potential private sector rescues, one involving Richard Branson, which went nowhere. Twelve years on, some officials muse that more drastic action such as a break-up of the banks to introduce more competition might have been a better policy. Even more profoundly, as the world showed signs that deflation rather than 1970s-style inflation was the problem, the Treasury was slow to adjust.

Too clever by half

The immediate legacy of the financial crisis was austerity: fiscal tightening in response to the ballooning deficits and debt triggered by the collapse of the banking system and the ensuing sovereign debt crisis in the eurozone. All natural territory for the Treasury. But the second—political—legacy was not so amenable to its technocratic ways: the rise of populism symbolised by Brexit, the election of Donald Trump and the decline of mainstream centre left and right parties in continental Europe. A nagging question, as the department ponders how to restore its grip, is whether or not the first caused the second.

George Osborne still defends austerity on the grounds that the public deficit in 2010 burst through 10 per cent of GDP. Mobilising public support for belt tightening was vital. Political risk and financial market pressures weighed heavily. And the new government was a coalition, something untested in modern Britain. “The big question was whether it could hold together,” said Osborne.

Treasury officials led by Macpherson strongly favoured austerity, but the balance between spending cuts and tax increases was a political choice. Osborne’s overwhelming emphasis on spending boxed in Labour on tax, with the added benefit—for those of Conservative leaning—of shrinking the state. Although he points out that his recipe helped the Tories win the 2015 election, Osborne conceded to me he may have “oversold” the policy.

It is now widely recognised that austerity caused serious damage to public services, notably local government and the criminal justice system. And while David Cameron won a slim majority in 2015, he suffered a catastrophic defeat in the Brexit referendum a year later in which fatigue at the government’s austerity may have played a role.

Brexit inflicted damage on many UK institutions, but few more than the Treasury. In the referendum campaign, Osborne mobilised the department behind “Project Fear,” a raft of dire official warnings about the immediate economic consequences of leaving the European Union. This kindled doubts about civil service impartiality—a poisonous legacy that persists. Overall, four years of Brexit negotiations, deal or no deal, have proved a gigantic distraction for the best minds in the government. Moreover, the talks are led from No 10 and the Cabinet Office, putting the Treasury in the back seat.

Another post-crisis, post-Brexit pattern is less obvious but no less important: the decline of economics as the determining factor in Whitehall policy-making. Some like Mervyn King, former governor of the Bank of England, suggest that the Treasury’s own economic expertise weakened after the transfer of monetary policy to the Bank in 1997; but the absence of serious economic debate also speaks to the indifference of Boris Johnson’s Vote Leave government.

Jill Rutter, a senior Treasury official for 19 years who works at the Institute for Government, said that the vacuum has been filled by the securocrats with no previous Treasury background. This is a departure, as “Treasury men” (as they almost always used to be) would traditionally step up or be seconded to “the centre”: like Paul Gray and Jeremy Heywood, who went from HMT to the prime minister’s private office, and Gus O’Donnell, who was shuffled straight across to be Cabinet secretary. But Theresa May chose Mark Sedwill as her Cabinet secretary, while Johnson has chosen as his successor Simon Case, a linguist who has spent time at GCHQ, the spy agency, plus spells as Cameron’s and May’s private secretary as well as managing Prince William. Meanwhile, Ivan Rogers, a Treasury man to his bones and an EU expert, did not last long as ambassador in Brussels and top counsellor to May during the Brexit negotiations.

Sunak therefore faces a new—and more testing—set of power relationships in Whitehall, where the Treasury no longer has its men and women in all the places that matter (though the appointment of ex-Treasury man Dan Rosenfield as the new Downing Street Chief of Staff suggests that HMT is seeking to take back control).

Different this time?

In spring 2020, the new Chancellor had arrived at the Treasury after Downing Street’s “constructive dismissal” of Sajid Javid, a Cummings-led assault on Treasury power. Sunak responded forcefully to the Covid-19 emergency. Treasury officials drew up measures from “bounce back loans” to an unprecedented “furlough” scheme, guaranteeing 80 per cent of wages to deter companies from laying off workers. While there were initial defects, particularly coverage of the self-employed, the speed of response was impressive. “They got the money out of the door,” said Rutter.

Sunak is a former Goldman Sachs banker and hedge fund manager, more free market than most of  his Cabinet  colleagues. Photo: Matt Dunham/AP/Shutterstock Sunak is a former Goldman Sachs banker and hedge fund manager, more free market than most of his Cabinet colleagues. Photo: Matt Dunham/AP/Shutterstock

Sunak is a former Goldman Sachs banker and hedge fund manager, more free market than most of his Cabinet colleagues. Photo: Matt Dunham/AP/Shutterstock

By early autumn, the Chancellor was ready to taper off emergency support. But when the virus returned, there was no clear plan to tailor economic aid in the government’s regionally tiered system shutting down parts of the economy. This led to the penny-pinching standoff with Andy Burnham, the Mayor of Greater Manchester. The sums, a matter of a few million pounds, were put in perspective by the cost of a second lockdown; the compensation denied Manchester as unaffordable was suddenly deemed affordable and offered nationwide.

Today, the verdict on Sunak’s emergency aid package looks mixed. It prevented an explosion of unemployment, albeit at the cost of a budget deficit skyrocketing to more than 15 per cent of GDP, the highest outside the two world wars. The support schemes were vulnerable to fraud. As my former colleague Chris Giles has pointed out, the government has spent more money fighting coronavirus than almost all comparable advanced economies, but its economic performance is worse than G7 peers, with the economy set to shrink by 11.3 per cent in 2020. (In fairness, most economists blame the tardy decision to impose a lockdown and social distancing in the spring.)

Could this be the crisis—unlike all those that have gone before—that will ultimately weaken rather than strengthen the Treasury? The challenge is to forge a path to recovery amid a fog of uncertainty, with the only bright spot being the coming of a vaccine in the first quarter of 2021. Sunak wisely opted for a single-year spending review, resisting pressure from colleagues to start spending to fulfil the election manifesto of “levelling up” the north.

“Jealousy and mutual suspicion between No 10 and No 11 could yet trigger another political earthquake”

Ben Wallace, the Defence Secretary, demanded a clearer planning horizon and prevailed—in mid-November he unilaterally secured a four-year, £4bn-a-year increase, bypassing all the usual disciplines and procedure of the spending round, leaving the Treasury looking marginalised at the moment the country is plunging deep into the red. Sunak countered with a banner tweet, claiming credit for “the biggest defence budget boost for 30 years,” coupled with his signature—but the damage was done.

Mervyn King said the Treasury should accept a substantial rise in the national debt in the short term, a natural response to a shock like Covid. With interest rates at record lows, and likely to stay that way for the foreseeable future, debt is not the immediate threat. But it could be a threat to stability in the future, and the fiscal deficit must be addressed at some point. The timing is what the mandarins are focusing on right now.

Another challenge concerns employment and the state of private companies, especially small and medium enterprises. Coronavirus has devastated sectors like hospitality and travel. It has also turbocharged the internet, heralding profound structural changes in the economy. The trade-offs between public health and the public finances will give way to hard questions about which companies and sectors will survive. Brexit will only compound the disruptive impact.

Oxford and Stanford-educated, Sunak is a former Goldman Sachs banker and hedge fund manager. He is a Brexiteer by intellect and temperament, more free market than most of his Cabinet colleagues. He will not want an economy on semi-permanent life support, but he knows that the withdrawal of stimulus will inevitably produce multiple casualties. “He must accept the pain of [business] deaths,” said a former senior Treasury official, “otherwise you just end up postponing the inevitable reckoning.”

The road ahead

In the best of all worlds, the Treasury would be integrating its plans for a post-Covid recovery with a vision for the post-Brexit economy. Sunak declined to be interviewed for this article, citing understandable pressures on his time. So, mindful of Treasury parsimony, here is some free advice.

First, follow Nigel Lawson’s example and become a reforming chancellor by developing the tax base. The green revolution is transforming business, especially the car industry. Fuel duty will no longer provide the revenues of the past. New sources of taxation are needed to fund innovation and it’s time to look hard at the digital economy. During the pandemic, Big Tech has emerged as the big winner. Amazon, Facebook and Google should pay a fairer share—resist Treasury defeatism on how much can be done on this.

Second, recognise the Scrooge approach to public spending has run its course and take another look at welfare. There is a fine balance between fostering a dependency culture and ensuring an adequate safety net, but an increase in benefits might make people more likely to consume. The Resolution Foundation’s suggestion of a Health and Social Care Levy is worth considering as a way to fix a crumbling corner of the welfare state without damaging the books.

Third, stop infantilising local government. The Treasury’s suspicion of local authorities goes back to the days of Derek Hatton in Liverpool and “Red Ted” Knight in Lambeth in the Thatcher years. It is outdated and damaging. It is time to build on Osborne’s devolution of power to local mayors and the Northern Powerhouse. Cities are the new engines of growth, especially if linked to higher education.

Fourth, rack up spending on education and training to boost skills in Middle England as means of redressing Britain’s biggest weakness: the productivity gap. Despite the overwhelming focus on industry tariffs in the Brexit negotiations, Britain is a services economy. Has the Treasury fully grasped that a highly regulated, post-crisis financial services sector will never produce the returns or, crucially, the tax receipts that Chancellor Gordon Brown once enjoyed? Other sorts of productive and high-skilled sectors will have to be nurtured to bridge the gap.

Dominic Cummings’s promised revolution in the civil service amounted to random acts of violencePhoto: Hollie Adams/Bloomberg via Getty Images Dominic Cummings’s promised revolution in the civil service amounted to random acts of violencePhoto: Hollie Adams/Bloomberg via Getty Images

Dominic Cummings’s promised revolution in the civil service amounted to random acts of violencePhoto: Hollie Adams/Bloomberg via Getty Images

Fifth, reform the Treasury in order to preserve its strengths at the heart of government. Slow down the internal jobs merry-go-round that generates excitement and promotion prospects, but at the expense of deep expertise. Open up some of the senior jobs to outsiders, if only for temporary secondments. No more monoculture!

The temptation to maintain the status quo will be overwhelming for Sunak as he grapples with the economic consequences of coronavirus. The Treasury is by instinct risk-averse. Its job is to keep the ship of state afloat. Or as the Financial Times’s Martin Wolf puts it: “To stop Britain becoming Italy.” But there are new forces at work that cannot be wished away. Brexit will bring a serious repatriation of powers from Brussels, from competition policy to agriculture and international trade. In the past, the Treasury has often been adept at yielding some power (monetary policy to the Bank and independent scrutiny via the Office of Budget Responsibility) in return for seizing control in other areas. It might not be possible to repeat the trick. With the rise of the securocrats like Simon Case, its writ no longer runs so large.

The departure of Cummings from No 10 is on balance good news for the Treasury. His promised revolution in the civil service amounted to random acts of violence such as the removal of six permanent secretaries and fireworks in the sky. Tom Scholar, Treasury Permanent Secretary, was said to have been on Cummings’s hit list, but he has seen him off as well as half-baked plans to restructure or break up HMT.

As for Sunak, with his Silicon Valley “move fast and break things” instincts, he may share some of Cummings’s desire for far-reaching change. But he would be better sticking to his proven power-base at the Treasury, where most if not all the serious policy trade-offs continue to be struck. The ultimate test will, after all, be management of the Covid emergency. “Rishi’s best bet is to stick with the grown-ups,” said one long-time Treasury watcher. “He should put aside any doubts and [then]—for better or worse—forge an alliance with the Prime Minister.” 

By this analysis, Sunak’s media elevation to PM-in-waiting is not only premature but risky. Jealousy and mutual suspicion between No 10 and No 11 could yet open up the San Andreas fault and trigger another political earthquake.

Britain needs a period of stability and recovery, with attention to the future model of a post-Covid, post-Brexit economy. Sunak stands out as the steadiest, most articulate member of an unimpressive Cabinet. He should aim to stay in the driving seat of a re-modelled Treasury car: less the effortlessly superior Rolls-Royce of old, which was never quite as good as it thought. More a sleek, environmentally sensitive, high-tech Tesla—with a more realistic valuation.

Lionel Barber was editor of the Financial Times from 2005-2020. His diaries, “The Powerful and the Damned,” are published by WH Allen