One of my personal political heroes is former Chilean Minister of Finance Andrés Velasco. Stop looking at me like that. It’s perfectly normal. In case you don’t pay attention to Chilean politics, Velasco was Finance Minister from 2006 to 2010. During that time, he first hoarded the results of a boom in tax receipts so that by 2007, Chile was running a budget surplus of some 8% of GDP.
Then, when the Global crisis struck, he moved counter-cyclical policy in the opposite direction, putting in place the second largest fiscal stimulus (relative to size of the economy) in the world. Truly, a hero for a hard Keynesian!
On Monday, thanks to Policy Network’s ‘progressive politics in fragmented times’ conference, I had the chance to hear him speak, and to have a brief conversation with him.
Velasco’s overall talk was very interesting – reflecting on the differences and similarities in the world economy seen from the perspective of an emerging economy, rather than a developed one – though he noted that Chile’s PPP GDP/Capita was not that far below that of Greece before the Crash, and may well be higher than Greece’s now.
He also reflected on the successes and failures of his time as Finance minister – the successes including the acceptance of fiscal responsibility as a progressive aim by the centre-left, even when Budget surpluses were particularly strong. The failures including a lack of communication of the ‘why’ of this political value – a sense that instead of having a moral and political purpose, budget rules were mere desiccated technocracy.
One of the most interesting aspects of the Chilean fiscal rules is that they specifically include reference to the uniqueness of the Chile as a major commodity exporter. To put it crudely, a large part of the Chilean governments tax base is dependent on the price of copper. In the boom years, the contribution of copper to the Chilean budget was somewhere between a fifth and a third of total receipts. So when the Chilean government looks at their structural fiscal position, they explicitly include the price of copper in their calculations. If it is high, then the government has to run a higher surplus. That’s why the budget surplus from 2005-2008 was so high. Norway has a similar approach to the price of oil.
This is something that has gnawed away at me for a while when it comes to the UK. One of the most effective critiques of the last Labour government is that its fiscal optimism was based on a continuing surge in finance sector growth. As Tony Dolphin put it for IPPR:
“In the last decade, the UK was so dependent on financial services to produce growth that the share of financial and insurance services in total output increased from 5.4 per cent in 2000 to 9.1 per cent in 2008 and to 10.4 per cent in 2009 (when activity in other parts of the economy was hit harder by the recession than in the finance industry). Back in 2007 this expansion of finance was widely seen as the UK exploiting a competitive advantage; now – given the effect of the financial crisis on the rest of the economy – it looks more like foolish over reliance on a single sector.”
The UK Finance sector contribution to the exchequer wasn’t quite at Chilean Copper levels, but was significant. Just before the crash, the City of London estimated the financial sector contributed some 13.9% of Fiscal revenue (obvious source warning, however).
This had huge post crash consequences too. As Nick Pearce has pointed out
” Fully a quarter of all corporation tax came from financial services, but this revenue fell from £10.3 billion in 2007/08 to £4.5 billion in 2009/10, while stamp and share duties fell from £14.1 billion to £7.9 billion. As a result, with a similar loss of output to Germany and a proportionately smaller stimulus package, the UK registered a fiscal deficit of 11 per cent of GDP at the peak of the crisis, compared to only 4.3 per cent by its continental neighbour.”
Others have gone so far as to call Britain’s economic situation as suffering from a ‘Finance Curse’, similar to the ‘Resource Curse’ of commodity exporters.
One answer to this is diversification of the economy. This has been a regular post-crash reference point for politicians of all parties, whether in the form of marches of makers, regional growth, small business support and innovation investment. Theorists and political economists have talked on much the same lines.
Important though this is, it is damned hard work to deliver. Indeed, much of the debate over the ‘varieties of Capitalism’ debate in political economy is over whether such a shift is even possible.
This leads me to think a rule-based response is required as much as a political economy one. Put simply, if the UK exchequer is highly exposed to variation in the financial services industry, shouldn’t we incorporate that exposure into our fiscal rules, much as Chile does for their commodities exports? If Financial Services tax income is rising quickly, we shouldn’t include all that income in our short-term spending models.
This is not a new idea, or my idea at all. Nick Donovan and Victoria Barr proposed a creating Financial Services ‘Rainy Day Fund’ for the Fabians in 2012, based on exactly these principles.
I did get the chance to ask Mr Velasco whether such an idea might work in the UK, though. While we were only chatting informally, he said that it could. Perhaps it is a successful social democratic idea we could profitably steal.