The Treasury is the most powerful institution in Whitehall. It is actually a super-ministry combining functions separated in many other countries: management of the economy and control of the public finances.
These two functions are not accorded equal weight and never have been. The Treasury has always been primarily a finance ministry that views its main task as ensuring the nation’s budget arithmetic adds up.
Down the ages, the Treasury has argued there is nothing incompatible about its two objectives. Running a tight ship helps growth, it is said, because it leads to the financial markets having more confidence in the government. If the City is relaxed about the public finances it charges lower interest rates on the money it lends to the state. Lower interest rates lead to higher growth.
Conversely, trying to stimulate the economy through higher budget deficits doesn’t work because the extra public borrowing leads to a loss of confidence in the markets, higher interest rates and lower growth. In the jargon of the trade, public borrowing crowds out private investment.
This doctrine has been challenged down the years. Keynes railed against the so-called “Treasury view” when he was making the case for higher public investment to tackle high unemployment in the late 1920s and early 1930s.
Thirty or so years later Harold Wilson’s 1964 Labour government thought the way to raise Britain’s growth rate was to set up a bespoke ministry – the Department for Economic Affairs (DEA) – completely separate from the Treasury and run by a heavy-hitting cabinet minister, George Brown.
Yet Wilson effectively neutered the DEA by ruling out a devaluation of the pound. An over-valued exchange rate meant the Labour government had no chance of hitting its ambitious growth targets. Financial stability was accorded a higher priority than the real economy. The Whitehall turf war between the Treasury and the DEA became a no contest.
Tony Blair’s government tried a different solution. Under Gordon Brown, the Treasury sucked in functions from other departments and became a ministry for everything: welfare, regional policy, productivity, overseas aid and jobs.
But since Labour fell from power in 2010, the Treasury has reverted to a more traditional approach. The size of the budget deficit that resulted from the financial crisis alarmed not just the incoming chancellor, George Osborne, but his senior mandarins as well. The over-riding aim of Treasury policy from May 2010 onwards was to cut spending to get the deficit down. It was left to the Bank of England to stimulate growth through ultra-low interest rates and quantitative easing. Vince Cable, when he was business secretary in the 2010-15 coalition government had plenty of interesting ideas for reviving manufacturing but was forced to live off the scraps from Osborne’s table.
But this approach failed to recognise three things: that there was a limit to what monetary policy could do; the hit to growth that would be caused by over-hasty and over-aggressive application of austerity; and the extent of the damage left by the financial crisis. Each year the Office for Budget Responsibility (OBR), the body given the job of economic forecasting by Osborne, predicted that productivity growth would return to its pre-crisis levels and each year it was disappointed. In the end, the OBR simply accepted that even with a rising population the economy could only grow by around 1.5% a year – which is what it has been doing for the past couple of years.
The Bank of England thinks there is nothing more it can do to boost Britain’s growth rate without triggering higher inflation, which is why it is gradually raising interest rates. Any pick-up in the trend growth rate from 1.5% will come about from improvements to the supply side of the economy, which will mean higher and better directed investment, innovation, and a better-skilled workforce.
The economy has not changed fundamentally in the past decade. Consumer spending is the mainstay of growth; manufacturing is weak; the trade deficit troublingly wide. These are age-old problems there before Britain joined the European Economic Community, have remained unsolved in the years since, and will remain to be tackled whatever Brexit outcome is arrived at.
The EU referendum led to some soul searching in government. Why had people in the old industrial areas voted to leave the EU in such numbers? Why was the economy so unbalanced between north and south? Why were so many of the jobs being created low skilled and low paid?
These were the right questions. But while the EU referendum made it easier to identify the problems, it also made it harder to start finding the solutions because so much of the government’s focus for the past two and a half years has been on Brexit rather than on what needs to be done to make a success of its industrial strategy.
That inevitably brings us back to the power of the Treasury to stop things happening. Labour’s answer to Whitehall’s imbalance of power is to give the Bank of England a productivity target to sit alongside its inflation target. But the shadow chancellor, John McDonnell, has yet to make clear how Threadneedle Street could do this given the limited policy tools at its disposal.
An alternative would be to give responsibility for the industrial strategy and supply-side reform to a new properly-funded department for the economy. That would, of course, be resisted by the Treasury, and wouldn’t be enough on its own. But put the most senior member of the government in to run the new department and announce that the way to get the public finances right was to get the economy right rather than vice versa and there might be real change.