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Question of the Week. Should governments save money?


We all know politicians can spend, and that they fund this largesse by taxing citizens or by borrowing (though note that the £1 trillion of UK national debt and £10 trillion of US national debt still has to be paid for by yet more taxation).

But should our chancellors and financial secretaries actually aim to generate long-term savings accounts?

The idea of governments saving as well as spending has suddenly taken wings. We have the stated intention of the SNP to create not one but two separate oil funds, in the wake of a Yes vote next year. But the notion has also taken root in the Tory Party.

At the Conservative conference Chancellor Osborne surprised everyone by suggesting he not only wanted to eliminate the annual budget deficit but start running annual surpluses on the revenue account by 2020, and match any capital borrowing strictly to the rate of economic growth.

Given that Mr Osborne is still struggling to eliminate the structural deficit – spending more on revenue items such as wages than is covered by current tax receipts – talk of budget surpluses might seem a mite premature. But the Chancellor gets brownie points for the sheer audacity of his proposal. 

The Institute of Directors welcomed the idea, saying: “breaking government addiction to debt and achieving a surplus in public finances is the most important ambition any administration can have”.

However, the speed with which Osborne’s announcement disappeared from the blogs and articles of the commentariat suggests that no one took it very seriously.

Certainly Ruth Davidson, the Scottish Tory leader, this week happily savaged Alex Salmond for pressing on with the idea of an oil fund – surely no different in principle from the Conservative chancellor’s notion of running a permanent budget surplus.

Ms Davidson was responding to the publication of internal advice from civil servants given to the First Minister regarding the mechanics of how an oil fund might work.

One such civil servant had noted that Scotland ran a budget deficit in 20 of the last 21 years, even during the main North Sea boom period. One immediate (though narrow) interpretation is that creating an oil fund would require spending cuts or an increase in taxes. Ms Davidson duly reminded Alex Salmond of this.

However, it did not seem to occur to the Scottish Tory leader – who is normally as bright as a button – that she was accusing the First Minister of exactly the same thought crime as Chancellor Osborne.

Indeed, Labour in the House of Commons happily pilloried the chancellor using exactly the same point as Ms Davidson: surely running a permanent budget surplus implies reduced public spending, or above necessary tax rises, to generate the required revenues?

One could even be a bit contrarian and argue that government debt (within limits, of course) plays a very positive role in the economy that would be undermined by the advent of a permanent surplus. The issuing of government debt provides the financial markets and pension funds with a reliable investment asset. The demand for public bonds and treasury bills also provides the financial markets with their main source of liquidity. Take away the national debt and the financial system might freeze.

So what is the theoretical case for governments saving on a permanent basis?

The main argument for an oil fund is that it converts a wasting physical asset into a permanent financial one. The oil will run out one day and with it the tax base it provides. But use some or all of the interim oil taxes to invest in equities and bonds, and you have a permanent asset that yields a permanent fiscal return to the fiscal authorities.

The classic example here is the Norwegian Government Pension Fund, which currently commends assets worth around £450 billion.  The fund is Europe’s biggest single equity investor.  It is mandated to hold 60 per cent of its assets in stock, 35 per cent in bonds and 5 per cent in real estate.

However, there is an alternative view. Mrs Thatcher put this forward when she rejected a proposal for a UK oil fund by the then Governor of the Bank of England, Gordon Richardson in the early 1980s:

1. Sterling’s strength as a petrocurrency would allow private UK investors to buy foreign assets cheaply, effectively creating a huge offshore “oil fund” that generated taxes for the Treasury.

2. By leaving the investment decision in private hands, the commercial effectiveness of such investment decisions would be maximised – note that the Norwegian Pension Fund is subject to controversial political rules on what types of asset it can invest in.

3. By using oil revenues to reduce domestic taxes, the Thatcher government was passing on the windfall gains directly to private individuals; i.e. the real oil fund was the huge growth in private ownership of houses in the last decades of the 20th Century.

But these points can be contested.

First, the petrocurrency argument has nothing to do with the separate issue of whether or not to create an oil fund – offshore investments will happen anyway.

Second, an oil fund is a strategic instrument that has significant political value distinct from the economic gain that is achieved by leaving the marginal investment decision in private hands.  A sovereign wealth fund (of which an oil fund is one type) yields macro political and economic clout (viz. the various Chinese sovereign funds). It also acts as a useful counter-cyclical economic tool by providing collateral in case of emergency public borrowing in a crisis.

Above all, a well-managed sovereign wealth creates confidence in the state’s finances - a confidence that will be registered in lower borrowing costs and a strong currency. For instance, Norway’s international credit rating is AAA.

As for the housing wealth argument, the actual effect of using North Sea oil revenues to subsidise the UK domestic property market was to create a permanent asset bubble.  This has de-stabilised the economy on a semi-permanent basis, stimulated de-industrialisation by artificially favouring consumption over investment; and funded our bloated banking sector.

Was it really worth it?

I suspect the net costs of recurrent property bubbles and the 2008 crash is far greater than any gains. An oil fund (with its beneficial impact on interest rates) plus a more rational housing market might have served the UK better in the longer run.

That said, there is a reasonable point to be made that it is more difficult in the current global economic circumstances for a government in Scotland or the UK to start saving, whether it is to run a budget surplus or to create a permanent sovereign wealth or oil fund.

There is a solution, of course, as far as Scotland is concerned.

An independent Scotland could go the Chinese route and use its foreign currency earnings as the basis of its sovereign wealth fund – not variable oil tax revenues - assuming Scotland had its own currency. Foreign currency earnings from Scotland’s oil and whisky exports alone run to circa £50 billion per annum.

There is a final advantage to the concept of politicians saving rather than spending. It would make them focus on providing value for money and on constructing a more modest state.