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The British government's strategy to reduce public sector net borrowing by 3½ percent of GDP between 1996-97 and 1999-2000. The approach includes prudent management of public finances, investment, and public service reforms, all underpinned by two strict fiscal rules: the golden rule and the sustainable investment rule. The document also discusses the importance of economic stability, encouraging work, and raising productivity.
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Stability and Investment for the Long Term Chapter 1 Introduction Chapter 2 Sustainable growth and employment The objectives Achieving sustainable growth and employment Assuring greater economic stability Encouraging work Raising productivity EMU and economic reform Chapter 3 The fiscal framework: prudence and prosperity The Code for Fiscal Stability The fiscal rules Setting the stance of fiscal policy Planning and controlling spending Debt management policy Annex 3A: The new spending aggregates Chapter 4 Fiscal strategy: the next three years The Comprehensive Spending Review Public spending over this Parliament Meeting the fiscal rules Annex 4A: Time-series for key fiscal aggregates Annex 4B: Financing policy The Economic and Fiscal Strategy Report and the Financial Statement and Budget Report contain the Government's assessment of the medium-term economic and budgetary position. They set out the Government's tax and spending plans, including those for public investment, in the context of its overall approach to social, economic and environmental objectives. They will form the basis of submissions to the European Commission under Articles 103 and 104c of the Treaty establishing the European Union.
The first Economic and Fiscal Strategy Report Stability and Investment for the Long Term reflects the Governments commitment to a more open and transparent approach to economic policy. It explains how the Governments new fiscal approach will help to achieve the central economic objective of high and stable levels of growth and employment. This strategy is based on prudent management of the public finances to build a platform of stability, a phased programme of higher public investment and more efficient use of public assets, and reform and modernisation of our public serviceseach element underpinned by stable and long-term plans. It combines prudence and stability in public finances with investment and reform in public services. It is important that the Governments strict fiscal rules are met. Therefore, in a decisive break from the past, the Government is introducing a tough new regime for the long-term control of public expenditure. The public spending round has been a feature of British economic life since the early sixties. It has established an annual cycle of year-on-year incremental bids by departments; settlements reached by bargaining over inputs rather than analysis of outputs and efficiency; excessive departmentalism; a split between public and private provision; and a bias towards consumption today rather than investment in our future. The new approach to public spending tackles these deficiencies. It is based on multi-year plans rather than an annual cycle; a clearer distinction between current and capital spending; services justified by proper analysis of their effectiveness rather than bargaining over inputs; and the coordination and integration of services rather than departmentalism and a piecemeal approach to spending. The new system will also be based on a proper understanding of the role and limits of government: a shift from the state only as owner, manager and employer to the state also as facilitator and partner. A key part of this approach is the two strict fiscal rules, first proposed in the Governments election Manifesto, that will govern policy over the course of this Parliament: the golden rule : over the economic cycle, the Government will borrow only to invest and not to fund current spending; and the sustainable investment rule : net public debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. These rules are consistent with the common sense principles set out in the Code for Fiscal Stability and place Britain at the forefront of international best practice. They also recognise the important distinction between current and capital spending. This Report sets the stage for the conclusions of the Comprehensive Spending Review (CSR) by setting a firm envelope for growth in total public expenditure over the next three years. These plans are fiscally prudent and sustainable. They not only lock in the fiscal tightening achieved over the past yearthe largest since 1981but carry it into 1999-2000 in line with the tightening projected in the March Budget. On prudent assumptions, to allow for inevitable uncertainties, the plans generate a surplus on current budget over the cycle and also reduce the ratio of net public debt to GDP to below 40 per cent over the economic cycle as the economy returns to trend. Proper investment by the public sector, and better management of the states assets, are also vital. In the past, cuts in capital expenditure were made too often as a means of accommodating short-term pressures elsewhere. The consequence has been a significant deterioration in the public sector capital stock and a legacy of inefficient use of productive assets.[ 1 ] The Governments approach addresses these shortcomings by making a clear distinction between current and capital spending. Building on a framework of stability, room has been found for an Investing in Britain Fund to provide for the renewal and reform of Britains infrastructure and public sector. This will boost growth and innovation and underpin public services. This strategy recognises the roles that public and private investmentseparately and togethercan play in developing Britains infrastructure. It is also supported by the Private Finance Initiative and public-private partnerships which act to promote the efficient use of resources, encourage value for money in public investment and provide a new source of
This Chapter spells out the Governments central economic objective of achieving high and stable levels of growth and employment. It also discusses what the Government is doing to address long-standing weaknesses of the UK economy. The key points made in this chapter are that: raising the sustainable level of economic growth and employment will provide greater opportunity, higher incomes, improved public services and higher standards of living for all; three areas are vital: economic stability, encouraging work and raising productivity; the Government has put in place major fiscal and monetary policy reforms to deliver greater stability, and it has also introduced a wide-ranging programme of structural policy reforms designed to encourage work and raise productivity; and these reforms are all in the national interest and they will also help to deliver the stability and flexibility needed to allow Britain in due course to take part successfully in the single European currency, should it choose to do so.
The Governments central economic objective is to achieve high and stable economic growth and employment. This objective recognises that: the level of output per head is a key determinant of our overall standard of living. It also provides the scope for assisting those in need and for meeting the Governments spending priorities. The Government is committed to raising the UK economys sustainable growth rate; and creating employment opportunities will not only promote economic growth but will ensure that the benefits of growth are shared throughout society. Economic growth is the key to raising incomes and living standards over time. The post-war Golden Age was an exceptional period of rapid growth (3 per cent per year on average), in which GDP doubled in the 25 years between 1948 and 1973. In contrast, growth over the following 25 years has averaged less than 2 per cent per year. The Government believes that, with persistence and well-judged policies, it is possible to improve on the recent record. A sustained increase in growth would have enormous consequences for income levels and the ability to sustain and improve public services. For example, if the sustainable growth rate were raised by ½ per cent a year that would add over 120 billion to the level of national income in 20 years time. Our quality of life, however, also reflects a wide range of factors besides measured incomesfor example, health, personal safety and the quality of the physical and social environment. Invaluable contributions made through unpaid household work, carers, and by those working in the voluntary sector are not captured in GDP. The amount of leisure time is another important factor in the quality of life. Our environmentin the countryside and in citiesis also crucial to our well-being. GROWTH AND THE ENVIRONMENT Economic growth cannot be considered in isolation from other aspects of development. In particular, consideration needs to be given to environmental factors to ensure that economic growth is sustainable. The Government is doing this by:
ensuring policy decisions take account of environmental costs and benefits; making greater use of economic instruments for the environment alongside regulation and voluntary agreements; encouraging more environmentally friendly transport and reducing greenhouse gas emissions through tax and duty changes; and promoting energy efficiency and renewable sources of energy. The Government is also taking forward work on environmental accounts and indicators which will help to promote growth which is environmentally sustainable. Later this year the Government will publish its Sustainable Development Strategy, setting out its views on the framework within which environmental, social and economic factors should be weighed and balanced.
Sustained growth will not just benefit those currently in work. A key element of the Governments strategy is to increase employment opportunities, develop a fair tax system and improve the provision of public services, to raise living standards for all. Higher employment will ensure that more people can contribute to Britains future. Additional jobs also means that more people are earning incomes, which raises their own standard of living and reduces the call on the public finances. Higher employment raises the level of national income directly. A modern economy is characterised by continuous innovation and change. The key to higher employment is not to stand in the way of change, but to equip people to meet the challenge of that change. The Governments tax, benefit and employment policies reflect this reality and seek to provide employment opportunity for allthe modern definition of full employment. Simply examining levels of GDP or average income per head may hide large disparities between rich and poor. The distribution of income in the UK has become more uneven since 1979, and by a greater margin than in the rest of Europe. But there is no reason why economic growth need go hand-in-hand with greater inequality. Quite the reverse: faster economic growth should reduce poverty and inequality directly through increased opportunities for work; and higher tax receipts increase the Governments capacity to assist those in need. The tax and benefit system must not blunt incentives. In particular, careful consideration needs to be given to the interaction with economic and employment growth. But a fair tax system produces substantial benefits through increased social cohesion, trust and honesty, and a climate more conducive to economic growth. 2.2 ACHIEVING SUSTAINABLE GROWTH AND EMPLOYMENT The UKs post-war growth performance has been poor compared with other industrialised countries. Some countries have not only caught up with, but overtaken the UK. As a result, GDP per head is now around 10 to 15 per cent higher in France and Germany, and around 50 per cent higher in the US. There is considerable scope to improve our growth performance and catch up with the higher incomes of other major economies. The Government has a key role to play in meeting this challenge by working in partnership with business, and ensuring that growth benefits everyone. In order to improve our growth performance, three areas need particular attention: assuring greater economic stability; encouraging work; and raising productivity. 2.3 ASSURING GREATER ECONOMIC STABILITY
At least part of the UKs poor growth performance can be attributed to macroeconomic instability. That is why economic stabilitybased on low inflation and sound public financesis a key platform of the Governments economic policy.
frameworks will generate the necessary confidence to encourage businesses and individuals to plan for the long term. 2.4 ENCOURAGING WORK In the three months to March 1998 there were 1.9 million people unemployed and a further 2.4 million people of working age who wanted a job but were either not seeking or not available for work. At the same time there is widespread evidence of skill shortages. Correcting this structural weakness requires a framework that rewards and encourages work. That means: helping people from welfare into work; and making work pay, by removing disincentives to work and ensuring decency and fairness in the workplace. It also means making individuals more productive by improving skills and helping people move up the employment ladder. This is covered in Section 2.5.1.
The Governments New Deal initiative to help young people back to work is now a national programme, guaranteeing new employment and training opportunities to all those aged under 25 who have been out of work for 6 months or more. In its first full year, around 290,000 young people are expected to enter the programme, with over 100,000 to be placed into regular employment. For those who do not find regular employment from the gateway programme of intensive job search, the New Deal offers the option of a subsidised job, full-time training, work with the voluntary sector or a place on the Environmental Task Force. All options include a training element, and those who complete their options will be given extra assistance to help them stay in work. This month also sees the national start of a new self-employment option; helping those for whom starting their own business offers the best route into the labour market. The response from employers has been very encouraging, with over 10,000 having signed the agreement to participate. Building on this success the Government is now extending the New Deal to long-term unemployed people aged over 25. The New Deal for lone parents is the first serious national effort to help lone parents who want work to find it, and New Deal opportunities are also being made available to people with disabilities, and partners of the unemployed who find themselves out of work. Alongside the New Deal, the Government is also developing approaches targeted on areas where long-term unemployment is particularly high. Five areas of the country have been selected as Employment Zones, where partnerships are developing innovative and flexible new approaches to make the best use of government funding. The New Deal for Communities will focus help on particularly disadvantaged housing estates, where poor employment prospects interact with wider problems of social exclusion, crime and poor housing.
For the majority of people in work, there are clear financial rewards. But for those out of work who are able to command only low wages, potential in-work income may not be large enough to provide an incentive to work. In addition, for those in low-paid jobs, the tax and benefit systems may mean that they have very little incentive to increase their hours worked, or their hourly wage. The tax and benefit system therefore needs to help those in need whilst not discouraging people from workingthe unemployment trapor from moving up the earnings ladderthe poverty trap. The 1998 Budget took important steps in tackling these problems through: a Working Families Tax Credit (WFTC) to replace the Family Credit system from October 1999; a new Disabled Persons Tax Credit to help make work pay for people with disabilities; and significant reform of National Insurance contributions to remove distortions at the lower end of the earnings distribution. These reforms will be underpinned by the national minimum wage. Together these reforms start to tackle the features in the tax, benefit and national insurance systems that distort the labour market; particularly through the effect they have on low paid workers, and those moving from unemployment into work. For instance, the reforms will cut the numbers of families facing high marginal deduction rates: the numbers facing rates of more
than 90 pence of any extra 1 will fall by about four-fifths. In addition, these reforms will boost the effective hourly wage rates for low paid workers. Every working family will be guaranteed an income for full-time work of at least 180 per week. And no family with earnings of less than 220 a week (half average male earnings) will pay net income tax. 2.5 RAISING PRODUCTIVITY Besides increasing the number of people in work, the other side of the growth strategy is to help each worker to become more productive. A productive labour force is essential to achieving high and stable levels of growth and employment. What is needed is a skilled and flexible labour force that is able to respond effectively to new challenges offered by a dynamic business sector. Measured by either output per worker or output per hour, the UK has a poor productivity record. US productivity leads the UK by about 40 per cent, and France and Germany are at least 20 per cent ahead of the UK. These large productivity gaps go to the heart of the UKs legacy of under-performance. Productivity can be raised by increasing and improving the stock of physical capital per worker and by raising skill levels. However, productivity growth cannot be considered in isolation from the fundamental role of innovation, nor from the competitive framework which drives it. Of clear importance is the need for: high levels of educational attainment and training; the workforce to be supported by sustained capital investment; markets to be open and competitive to create the right incentives for continuous improvement; and dynamic and innovative businesses continually developing new products and processes. In taking this forward, the Chancellor and the President of the Board of Trade have launched a joint programme of seminars with leading business people and others to work together to find ways of bridging the productivity gap.
High productivity is associated with an educated and skilled workforce. Improving the skills of those in work and ensuring new workers are highly trained will therefore help employers to raise productivity. An effective basic education is important for both individuals and the economy alike. Early investment in a childs education will help to raise growth by improving the employability of all, especially the least skilled, and relieving skill shortages. The self-confidence and skills that a good basic education instills can also help to prevent many social problems, and the costs they entail, arising in later years. There is evidence that the UK has a lower level of basic skills in literacy and numeracy than other major economies. The first step to address this problem is to enable a much higher proportion of 11 year olds to leave primary school with adequate skills in literacy and numeracy through: focused and intensive literacy and numeracy strategies; reduced class sizes for 5 to 7 year olds; and freeing up teachers time to teach. In the July 1997 Budget, the Government recognised the importance that well-maintained school buildings can play in helping to raise standards, both for pupils and teachers. The Chancellor allocated 1.3 billion from the windfall tax to tackle the backlog of school repairs. This New Deal for Schools has proved an effective measure, with a quarter of all UK schools having been allocated funding already. Learning basic skills at a young age is fundamental to success in later life. By the time they leave school, children should be able to read and write fluently and handle numbers confidently. The Department for Education and Employment has announced ambitious targets for both literacy and numeracy for 11 year olds. By the year 2002, 80 per cent of 11 year olds will have reached the standards expected of their age in English, and 75 per cent will have achieved the standards expected of their age in Maths (as against 58 per cent and 54 per cent respectively in 1996). The further education (FE) sector provides a key link between school and the workplace. In 1996-97 there were 1 million students studying full-time in the FE sector and over 2.8 million studying part-time. Of those students, over half were
Dynamic and efficient product markets are good for both consumers and for the economy as a whole. They give customers lower prices, more choice and higher quality; and they provide strong incentives for companies to innovate and improve productivity, driving forward economic success. Exposure to competition and trade sharpens incentives, encourages the diffusion of technology and opens up opportunities to catch up with the worlds leading firms. Moreover, increased market size allows greater specialisation and exploitation of comparative advantage. Episodes of trade liberalisation are, almost without exception, associated with rapid growth in trade and an increase in economic growth. The UK benefits, in a similar way, from inward foreign investments; while outward investment has enabled UK firms to expand and develop markets overseas. Maintaining a high level of overseas investment will produce better returns and help spread risks for UK savers. Over the past year, the Government has begun an ambitious programme to improve the dynamism of product markets. The approach has focused on encouraging competition, improving regulation and promoting open markets, through: introducing a new Competition Bill to create a modern framework for competition policy based on a tough and rigorous approach to abuses, whilst increasing transparency and accountability. The Government will also ensure that the Office of Fair Trading has the resources to implement these new arrangements and uses them effectively in those areas that will generate the greatest economic return; publishing a Green Paper on regulation of the utility industries. This sets out the Governments strategic proposals for these key industries for the next decade, with the objectives of fairness and efficiency. The aim is to set a long- term, stable and effective framework that safeguards the interests of consumers and shareholders and anticipates changes in market structure; and establishing an independent advisory task force to look at regulations protecting the interests of consumers and employeesanother element of an efficient market economy. A report will be published in September 1998. There is also a crucial international element to this agenda. In international groups the Government plays a leading role in pressing for further liberalisation of trade and investment and for competition policies which ensure free and open markets. In Europe, the Government recognises the need for a more effective Single Market. It is looking for action in a range of areas to improve the functioning of product markets, such as liberalisation of telecommunications and energy markets, public procurement and reform of agricultural support.
Research and development (R&D) and innovation by businesses is generally positively associated with economic growth in industrialised countries. The diffusion of ideas and technology has clear potential benefits for the wider community. Basic research also contributes to economic growth, by training skilled individuals for the business sector and by contributing to the stock of knowledge more generally. In aggregate, the amount of R&D undertaken by UK firms has declined relative to our competitors. Total R&D spending in the UK is ¼ to ½ per cent of GDP less than in most other major economies. UK businesses spend relatively more in high- technology sectors such as chemicals and less in medium and low-technology sectors. But the overall figures are heavily influenced by a few star performers, as nine companies undertake one third of all UK business sector R&D. The reforms to capital gains tax, corporation tax, and the initiatives to help small and medium-sized enterprises raise finance are important steps towards creating a more favourable environment for investment, including investment in R&D. In a wide-ranging review on how to improve the UKs record of investment in R&D, the Treasury and Department of Trade and Industrys consultative document, Innovating for the Future , identified several key issues to explore further, including: funding R&D, and the need to attract more finance into high-technology enterprises, especially in the early-stages of their development; the appropriate tax treatment of R&D expenditure and intellectual property; the right balance between the legal protection of intellectual property and encouraging the diffusion of innovation; and how the UK can exploit its science and engineering base better and develop management best practice, especially amongst technology-based companies. 2.6 EMU AND ECONOMIC REFORM All of these policies directed at reforming markets will help to deliver the vital flexibility should the UK choose to join the single currency. But high and stable levels of growth and employment are also an objective for the European Union on which much of our prosperity depends. The Government believes that economic stability, encouraging work and raising productivity are also key areas for the European Union. Economic and Monetary Union and the introduction of the single currency in 11 Member States on 1 January 1999 will help to lock in monetary and fiscal stability throughout Europe. The single currency will provide a competitive base to European business. Firms and consumers stand to benefit from the greater price transparency, the reduction of transaction costs and the elimination of exchange rate uncertainty. For these benefits to be realised in full the single currency must be based on solid foundations. More progress is required in two areas, fiscal discipline and economic reform. In particular: for labour markets, the key is to increase employability. With a single currency, it will be even more important for Europe to have a well-trained, adaptable and motivated labour force, able to adjust to changes in economic circumstances; for better functioning markets for products and services, Europe needs to build on the single market, promote entrepreneurship and improve access to finance. Within the single market this means liberalising markets and promoting better public procurement; and for deeper, more competitive and more integrated capital markets, the single market in financial services must be implemented effectively.
a clear distinction between capital and current spending; a greater focus on effectiveness and outputs rather than bargaining over inputs; and the coordination and integration of services rather than departmentalism and a piecemeal approach to spending. The new system will also be based on a proper understanding of the role and limits of government. In particular, it will recognise the state as not just owner, manager and employer but also as facilitator and partner. The desired outcome is the public and private sectors working together in the place of the discrete public-private split. 3.1 THE CODE FOR FISCAL STABILITY The framework within which the Government will formulate and implement fiscal (including debt management) policy is set out in The Code for Fiscal Stability , published in March 1998. The Code, which will shortly be given the force of law in the 1998 Finance Bill, ensures that the framework for fiscal policy is characterised by openness, transparency and accountability, mirroring the reform of the monetary policy framework introduced last May. The Code requires fiscal and debt management policy to be formulated and implemented in accordance with a set of five key principles that are fundamental to a commonsense approach to fiscal management: transparency in the setting of fiscal policy objectives, the implementation of fiscal policy and the publication of the public accounts; stability in the fiscal policy-making process and in the way fiscal policy impacts on the economy; responsibility in the management of the public finances; fairness , including between generations; and efficiency in the design and implementation of fiscal policy and in managing both sides of the public sector balance sheet. A number of other commitments follow from this. For example, governments must state explicitly their short and long-term fiscal policy objectives, and must ensure these objectives are consistent with the fiscal principles embodied in the Code. A further important requirement of the Code is that governments report regularly on progress in meeting their fiscal objectives. From now on, the familiar Financial Statement and Budget Report will be supplemented each year by an Economic and Fiscal Strategy Report, setting out the Government's long-term strategy and objectives. The present document is the first of this series. The Code also requires a Pre-Budget Report to be published, reflecting the Government's desire to draw upon the skills and experience of others when forming policy. Together, these reports will ensure that Parliament (in particular, the Treasury Select Committee) and the public, can scrutinise fully the Government's fiscal plans. 3.2 THE FISCAL RULES
The Government's first two Budgets have made clear that a key component of the new approach to fiscal policy is to distinguish between current and capital spending. Current spending provides benefits mainly to the current generation and reflects continuing programmes that are financed each year. Fairness and prudence dictate that this spending should be covered by current revenue. In contrast, spending on capital (ie investment) creates assets which support services and benefit taxpayers in future years as well as now. This does not imply that one type of spending is necessarily better than the other: both must be worthwhile and offer good value for taxpayers' money. Reflecting the important distinction between current and capital spending, the Government has set two strict fiscal rules to govern policy over the course of this Parliament: the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and
the sustainable investment rule: net public debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. The golden rule recognises explicitly the different economic nature of current and capital spending. In the past, governments set limits for total spending without distinguishing between current and capital spending. This led to bias against investment, which often constituted an easier (though short-term) target for spending cuts. Net capital spending by the public sector has fallen from 3 per cent of GDP in 1978-79 to ¾ per cent of GDP in the spending plans for 1998-99. This is explained only partly by privatisations and the growth of public-private partnerships. Many services have suffered-and growth too-as a result of inadequate levels of investment. At the same time, the sustainable investment rule recognises that borrowing for public investment must be constrained by the need to ensure a prudent debt ratio. In accordance with this distinction, the public finances are being presented in a new way, one which is more consistent with the underlying economic realities, as reflected by the move to Resource Accounting and Budgeting, national accounts concepts and international practice (see Chapter 4). In addition, the new spending control regime is based on the distinction between current and capital spending.
The Government's fiscal framework reflects a careful application of the principles of fiscal management which are embedded in the Code for Fiscal Stability. Transparency lies at the heart of this framework. It leads to greater certainty for decision makers and makes it possible for Parliament and the public to scrutinise policy decisions. Publishing this Report and setting out unambiguously the role and objectives of fiscal policy-in particular, the fiscal rules and their application-provides a clear demonstration of the Government's commitment to transparency in fiscal policy. By design, the fiscal rules will lead to greater economic and fiscal stability. As suggested above, this strategy allows decision makers to plan and invest for the long term, confident in the knowledge that the public finances will not be managed in a profligate fashion that might necessitate a sudden adjustment at some point in the future. The fiscal rules also represent a responsible approach to fiscal policy. The Government's commitment to keep debt at prudent levels recognises that excessive borrowing has detrimental economic effects. Borrowing will be used only to fund value for money investment, and the overall level of borrowing will be prudent and not excessive. Furthermore, these rules are consistent with the principle of fairness. By funding current spending from current revenue over the economic cycle, today's taxpayers bear the full cost of the public sector current spending from which they benefit. The Government also places considerable emphasis on ensuring that it raises revenue and uses taxpayers' resources in an efficient manner. The top-down approach, and firm plans for overall spending, derived from the fiscal rules, require the Government to prioritise its spending plans following a bottom-up review of spending priorities. The Comprehensive Spending Review (CSR) is the means of doing so. Moreover, by making a proper distinction between capital and current spending, the fiscal rules ensure that the planning and control processes no longer discriminate against capital spending. This will help ensure value for money in the provision of public services.
As noted above, fairness is one of the five principles of fiscal management embedded within the Code for Fiscal Stability. This principle implies that those generations that benefit from public spending should also meet the cost. The golden rule helps to match the costs and benefits of public spending across generations. It draws a clear distinction between current and capital spending, recognising that worthwhile capital spending by the Government provides benefits in the year of investment and over the life of the assets. It also recognises that current consumption must be controlled tightly and should not be financed by borrowing. However, the Government acknowledges that any such approach will be, to some extent, an approximation. Some aspects of current expenditure may also transfer the fiscal burden in ways that can not easily be quantified. It is clearly important to be aware of potential pressures on spending which arise over the longer term from demographic change. Development of long-term public finance projections is one way of approaching this issue. The Code for Fiscal Stability requires governments to publish illustrative long-term projections for the public finances, covering a period of at least 10 years. These projections are currently under development. Once completed, they will give an indication of how fiscal aggregates might evolve over time if policies remain unchanged. A further approach that has been used in several countries is to calculate what are known as 'generational accounts'. These
Debt performs a valuable function-it helps to spread the cost of public investment fairly across generations. Thus, the optimal level of debt is one that balances the need to undertake worthwhile public investment and fund this in a fair way, against the requirement that debt remains prudent and at levels that do not impose a burden on the economy, or future generations. Looking at the scope for worthwhile (value for money) spending on public investment is one of the tasks of the CSR. At present, the marginal benefits of public investment are likely to be relatively high reflecting under-investment in public infrastructure over recent years. The national interest will therefore be enhanced by spending on public investment rather than substantially reducing the public debt ratio beyond that projected in this Report. It is important to note, however, that the optimal debt level is likely to change over time as the stock of prospective worthwhile projects changes.
Over time, the Government intends to pay more attention to movements in the public sector balance sheet, which includes tangible assets as well as net financial liabilities. Public sector net wealth is the balance between total assets and liabilities. The balance sheet approach complements the golden rule because the surplus on the current budget should correspond reasonably closely to the change in public sector net wealth. The Government will also explore whether the balance sheet approach can lead to more effective management of the stock of debt. There are, however, data and conceptual difficulties that need to be addressed before the balance sheet can be given a more formal role in the fiscal framework. The introduction of Resource Accounting and Budgeting (RAB) offers a good opportunity to improve the balance sheet data, as well as further underpinning the golden rule. Subject to the outcome of a feasibility study currently under way, RAB could be further enhanced by the development of a whole of government account for the UK. The EU Stability and Growth Pact The Government is committed in principle to joining a successful single currency, provided the economic benefits are clear and unambiguous. Regardless of whether we join the single currency, fiscal policy in the UK will remain the responsibility of the British Government. At the same time Britain respects the Stability and Growth Pact and the excessive deficits provisions of the Maastricht Treaty. The Pact clarifies how the excessive deficit procedure will be implemented and strengthens the multilateral surveillance procedure set out in the Treaty. Only members of the single currency can be fined-by up to 0.5 per cent of GDP-if their general government financial deficit exceeds the Treaty reference value of 3 per cent of GDP. Under the Pact, Member States are required to publish Stability Programmes if they participate in EMU, and Convergence Programmes if they do not. The Stability and Growth Pact specifies a variety of information that must be produced in these Programmes, including the expected path of the general government financial deficit and the key economic assumptions that underpin the fiscal projections, such as the extent to which public borrowing is financing capital rather than current spending. The fiscal prospects outlined in this Report (see Chapter 4) are consistent with the terms of the Stability and Growth Pact. 3.3 SETTING THE STANCE OF FISCAL POLICY Sound management of the public finances is an essential building block for long-term prosperity. In particular, when setting the overall stance of fiscal policy, the Government must promote the long-term economic stability that is vital if Britain is to achieve high and stable levels of growth and employment. The Government's fiscal rules have been formulated to deliver economic stability. A key priority for the Government is to operate fiscal policy in a way that meets these rules with a high degree of certainty. It would be a serious mistake to divert fiscal policy away from this end in an attempt to manage short-term demand and inflationary pressures in the economy. Monetary policy is better suited to this task. Nonetheless, fiscal policy can provide a useful support for monetary policy in the short-term regulation of the economy so long as the fiscal stance remains demonstrably consistent with meeting the Government's fiscal rules over the economic cycle. For example, the significant tightening of the fiscal stance that has occurred over the past year, where public sector net borrowing (PSNB) has been reduced by around 19 billion or 2¾ per cent of GDP (the largest fiscal tightening in any one
year since 1981) undoubtedly helped restrain demand, supporting monetary policy at a time when the Bank of England has also been raising interest rates. At the same time, the fiscal tightening has put Britain on course to meet the fiscal rules over the present cycle. Apart from any discretionary adjustments to the fiscal stance, the automatic stabilisers , which operate through avenues such as unemployment benefits and the progressive tax scale, will also continue to have a stabilising impact on demand. For example, payment of unemployment benefits reduces the extent to which incomes fall in a recession, thereby limiting reductions in demand. The 'over the cycle' formulation of the fiscal rules reflects, and allows for, the impact of the economic cycle on the public finances. Stability in fiscal policy does not imply that the Government will no longer exercise discretion where it is sensible to do so, for example in response to clear and explicitly identified shocks. If a major economic or natural disaster were to occur, it is self-evident that the Government might need to deviate from its fiscal rules for a short period of time. Under the Code for Fiscal Stability, the Government would be legally obliged to be open about the reasons for the deviation, the alternative rules that would operate, and when and how it planned to return to its original rules and objectives. 3.4 PLANNING AND CONTROLLING SPENDING The public sector is spending over 330 billion this year, around 40 per cent of national income. Government uses this huge sum-equivalent to over 5,000 for every man, woman and child in Britain-to purchase a wide range of public services on behalf of the nation as a whole, including education (37 billion in 1997-98), health (43 billion), law and order (17 billion) and defence (21 billion). In addition, government transfers amount to very large sums; for example the Government spent 96 billion on social security in 1997-98. Given the sums involved, it is crucial that the Government obtains value for money. The quality of spending in the public sector has a large impact on the overall performance of the economy. Improving the effectiveness and efficiency of public spending is therefore a key objective of the CSR (discussed further in Chapter 4). Alongside this Review, the Government is making a major reform to the regime for planning and control of expenditure, to improve control of this spending and to promote longer-term planning. In order to make more efficient and effective use of public resources, departments will be given firm multi-year spending limits, within which they can prioritise resources and plan ahead, providing a more stable foundation for managing public services. Consistent with the fiscal rules, there will also be a clear distinction between capital and current expenditure to ensure that worthwhile capital investment is not squeezed out by short-term pressures in the way it has been in the past. This will pave the way for, and as far as possible anticipate, the planned introduction of RAB in 2000. RAB will also reinforce the planning and controlling of spending through providing a clearer distinction between capital and current spending and enhanced incentives for managing existing and new capital assets. There are four main features to the reformed planning and control regime. Overall spending plans will be based on sound economic principles, with a new distinction between current and capital spending. Decisions on spending will be based on the prudent and sound fiscal rules, rather than on an arbitrary target for expenditure as a proportion of GDP. The plans will cover all spending by the public sector, to be known as Total Managed Expenditure (TME). Within that, capital and current expenditure will be planned and managed separately to ensure that the fiscal rules are met, and to prevent capital investment being cut back to meet short-term pressures on current expenditure. Departments will be able to channel funds earmarked for capital expenditure into current spending only within an agreed margin which allows for some managerial flexibility or to finance private-public partnerships. This is consistent with the objectives of the Investing in Britain Fund discussed further in Section 4.2.2. Firm three-year plans will provide certainty and flexibility for long-term planning and management. Within these overall plans, the Government will set firm and realistic multi-year limits for departments' expenditure, wherever possible, with similar agreements for their running costs. Multi-year limits will cover a three-year period, but will be rolled forward for a further three years in 2000 when the Government plans to move to RAB. The limits will be set in cash to provide a clear incentive for departments to control their own costs and will be reviewed only
