Why the Covid-19 crisis will force the UK to rewrite the economic rulebook

In a transformed political landscape, the Treasury’s endorsement of austerity has left it marginalised.

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The Treasury options paper leaked last week to The Telegraph set out possible paths for reducing a coronavirus-induced budget deficit, which is forecast to reach £337bn. Dramatic measures such as increasing income tax and other major levies, scrapping protections on the state pension, and imposing a two-year public sector pay freeze were all pitched. The leaked proposals, which were intended not as a plan for the future but as options for ministers, were greeted with a chorus of dismay. 

Yet for all the consternation, particularly among a left hardwired to anticipate “Tory cuts”, it is more striking how dated these recommendations now appear. Everyone from the free-market Adam Smith Institute, to Boris Johnson, to the Treasury itself, which conceded in the leaked paper that Chancellor Rishi Sunak would accept a far higher level of debt, recognises that austerity is not the pressing concern it seems to have been in 2010. 

The primary architect of the lost decade since then, former chancellor George Osborne, is still urging severe spending cuts after the initial phase of the crisis passes. But he is a somewhat lonely figure: enthusiasm for cuts on the right side of the political spectrum is strikingly reduced. Unlike in 2008, when the Conservatives moved rapidly from supporting the Labour government’s spending plans to embracing austerity, the party today seems more unsure of its response to a far greater crisis. 

Beyond the first phase of the health emergency, there is no consensus on the Conservative side about the continuing scale and extent of state intervention. An emerging centre-right tendency emphasises the need for environmental investment, while a noisy free-market faction is demanding Trump-style tax cuts irrespective of the borrowing involved. None of this points to a consensus on deficit reduction emerging. It’s an open secret that neither Johnson, nor the advisers closest to him, set much store by the conventional view of government financing, in which taxes are presumed to be necessary to pay for public spending.

In the midst of all this, the independent power and influence of the Treasury, the country’s primary economic policymaking institution, looks rather diminished. Sajid Javid, a Chancellor more inclined to diverge from No 10 on the issue of spending, was summarily removed before the crisis, and replaced with a politician widely assumed to be more amenable to the Prime Minister and his coterie. 

Once dominant across British economic policy, the “Treasury view” has been discarded. This was the article of faith, deeply ingrained for generations of officials, that government spending had fundamentally no impact on the economy, with any increase in government expenditure simply “crowding out” private-sector activity. As a corollary of this, the primary task of the Treasury was simply to balance the books. 

Seemingly impervious to advances in economic thinking, the Treasury view lived on in the folk wisdom, expressed by one former second permanent secretary, that the department was primarily there to “stop things happening”. The idea that government might be needed to start things happening was always downplayed. Yet here is that same institution presiding over perhaps the biggest state intervention in the UK’s peacetime history – and even being forced to extend the support it offers.

But the authority of the Treasury was diminished even before Covid-19 struck. Public support for austerity had drained away over ten long, drawn-out years, as the sacrifices made and the visible decay of the public sector failed to deliver improving living standards. Labour’s flip from supporting “softer” austerity cuts, to outright opposition, helped shape the political argument. Both Theresa May and Johnson promised an end to austerity, with the latter leaning on a recalcitrant Treasury to deliver spending increases ahead of last year’s election. 

Criticisms of the institution have gone further, however, than its support for disastrous spending cuts. Taking a cue from former shadow chancellor John McDonnell, the Conservatives, even before the pandemic struck, promised to rewrite the Treasury’s “Green Book”, the rulebook which sets the parameters of government’s investment decisions. For a project to go ahead, it has to meet the stringent criteria laid down here. The stated aim, of course, is to prevent public money being wasted on white elephant investment projects. 

But the overall impact, as shown by economists Diane Coyle and Marianne Sensier, is to bias Treasury investment decisions towards London and the south-east. By insisting, as the Green Book does, that projects should be assessed on the basis of existing market prices and economic activity, government decisions about investment end up concentrating it in areas of existing relative success. In recent years, as IPPR figures show, this has meant Yorkshire receives £511 per head in transport funding, whilst London receives £3,636. These kinds of inequalities are not the result of individual policy decisions, but of institutional structures that work in a certain direction, over a long period of time, amounting to a chronic bias.

We may not, then, see a return to the Treasury of old. Arguments for a return to austerity start from a critically weaker place than they did in 2010, and the institution itself looks more politically exposed than ever. There is an opportunity for Labour to seize the ideological initiative by helping to forge a new consensus on the role of government in the economy. Perhaps, as I have argued in a report for Common Wealth, Jacinda Ahern’s government can provide a model, having overhauled the New Zealand Treasury to deliver the world’s first “wellbeing budget”. The former head of the Government Economic Service, Gus O’Donnell, is also among those now urging the use of far broader and more meaningful indicators of economic success. There should be no expectation of a return to the old ways of thinking and working. 

James Meadway is former economic advisor to shadow chancellor John McDonnell, and is currently writing a book on Corbynomics

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