Written evidence submitted by the Social
Market Foundation (SMF)
SUMMARY
1. Appropriate design of the OBR will be
essential to its credibility, longevity and capacity to provide
the best possible fiscal forecasts to guide policy. But in order
to determine that design, a full analysis of the reasons for the
failure of the old fiscal framework is needed.
2. Consistently over-optimistic revenue projections
over the past decade indicate a systemic bias in the way that
projections were assembled. This is commonly attributed to political
interference—a form of "top-down" bias. But given
the nature of the forecasting process—based on myriad finely
balanced judgements and assumptions made at all levels of the
process—it is all but inevitable that it is vulnerable also
to pervasive, if unintentional, organisational bias. It would
be naïve to imagine that the judgements exercised by civil
servants sitting within an organisation whose role is to serve
the chancellor could be immune from such bias. A small OBR with
minimal manpower will be unable to scrutinize the components of
the forecast in sufficient detail to truly own the output and
safe-guard against this, less visible, form of bias.
3. The need to separate inherently political
fiscal policymaking from essentially a-political forecasting is
clear. But splitting the functions is further complicated by the
fact that policymaking and forecasting are closely interconnected.
Those Treasury officials responsible for feeding into the forecast
are simultaneously needed in HM Treasury for their policymaking
expertise during the budget exercise. Those making the forecast
need to have a good grasp of policy and, currently, those making
policy are the only ones who can make the forecast.
4. The only effective and practical solution
to the problems of eliminating bias from the fiscal projections
is therefore to ensure that the OBR is sufficiently well resourced
for its officials to:
— take on the forecasting role of officials
at an early stage in the process, thus owning the forecast and
eliminating the potential for bias;
— have responsibility for a sufficiently
narrow range of policy, to enable them to get to grips with emerging
policy issues and their likely impact on the forecast; and
— be based outside the Treasury.
5. Safe-guarding the forecasting process
against both top-down and bottom-up bias will therefore require
a significantly better resourced OBR than the current small secretariat.
On the other hand, many fewer officials will be required than
the hundreds currently involved in the process in some way. Only
with this level of resource can the OBR as an institution address
the full range of reasons for the failure of the defunct fiscal
framework.
INTRODUCTION
6. This submission seeks to address the
following two issues for the Office for Budget Responsibility
(OBR) in relation to the Committee's terms of reference for this
enquiry:
7. This submission draws on original work
undertaken by the SMF in our recent publication "Forecasting
Independence: Taking the politics out of fiscal projections",
which is available to download from the website of the SMF. It
also draws on the comments by attendees at a seminar held with
Sir Alan Budd at SMF's offices in July 2010.
THE ELEMENTS
OF FISCAL
POLICYMAKING
8. Arrangements for fiscal policymaking
ultimately come down to a set of choices around two dimensions:
9. These choices are subject to competing
objectives such as the extent to which fiscal policymaking should
be political and accountable versus independent and technocratic;
and the extent to which decision-makers should be free to act
with discretion, or should be constrained by pre-ordained rules
or principles.
10. It is widely accepted that decisions
over what to tax and how spend are entirely political. Similarly,
decisions over when to spend and when to tax are usually deemed
to be political. An exception to this is the case of Germany,
where, from 2016 a balanced budget rule will operate, forcing
the government to balance its books at all points in the economic
cycle. However, the international consensus around who should
undertake the revenue and spending projections on which policy
decisions are made is moving in the direction of independence
from government, in the form of an independent fiscal council,
of which the OBR is one.
11. Nevertheless, the detailed design of
the OBR will be essential to its credibility, longevity, and capacity
to provide the best possible fiscal forecasts. In determining
the appropriate design, this note argues that a full analysis
of the reasons for the failure of the previous fiscal framework
is necessary.
THE LAST
GOVERNMENT'S
EXPERIMENT WITH
INSTITUTIONS
12. The self-imposed fiscal rules of the
previous government represented an important experiment in the
evolution of fiscal policymaking. The rules sought to articulate
formal standards by which fiscal policymaking could be judged
thereby increasing political accountability, even if the rules
themselves amounted to nothing more than statements of intent.
13. However, the current fiscal outlook, even
in the context of the global economic slowdown of 2008-10, must
be partly attributed to excessively loose fiscal policy in the
years preceding the financial crisis. The reputational costs to
the government of infringing their self-imposed rules may have
had some constraining effect on policy decisions, but it was clearly
inadequate to prevent the Government running a significant structural
deficit. As such, the fiscal policymaking framework provided by
the previous government's fiscal rules must ultimately be deemed
to have failed.
WHY DID
THE RULES
FAIL?
14. Gordon Brown's fiscal rules failed,
not because of over-optimistic GDP growth projections, but because
of consistently over-optimistic revenue forecasts. In analysing
the reasons for the rules' failure, the charge is that this must
be attributable to some form of systemic bias—whether intentional
or not—in the production of the forecast.
15. There is widespread belief that ministerial
pressure may have been at least partly responsible for the consistent
over-estimation of future revenue. This can be called "top-down"
bias. But top-down bias is not the only source of the problem—it
is only the most visible one.
16. It is all but inevitable that the forecasting
process is vulnerable also to pervasive, if unintentional, organisational
bias. The forecast is built on myriad finely balanced judgements
and assumptions made at all levels of the process—not just
on "big ticket" judgements over, say, the size of the
output gap. It would be naïve to imagine that the judgements
exercised by civil servants sitting within an organisation whose
role is to serve the chancellor could be immune from bias. Once
again, it is important to stress that this "bottom-up"
form of bias is most likely to be unconscious on the part of officials.
17. Essential to a full understanding of
why the previous fiscal framework failed is, then, an appreciation
of two kinds of bias: top-down political bias and bottom-up organisational
bias. This understanding has significant implications for the
design of the OBR in ensuring its independence, as well as for
determining the resources it should command.
INSTITUTIONS
18. The failure of fiscal projections under
the last government has led to a renewed interest in the institutional
arrangements that underpin fiscal policymaking. This reflects
a wider trend, over the past 13 years, of using careful institutional
design to improve public policymaking, particularly by separating
different functions according to the need for analytical independence
and political accountability. Good examples include the granting
of operational independence to the Bank of England, the establishment
of an independent UK Statistics Authority and the creation of
an independent Low Pay Commission to advise on the level of the
minimum wage.
19. Drawing on the success of these examples,
as well as studying overseas fiscal councils, the Conservative
Party in opposition announced that it would create an independent
Office for Budget Responsibility, responsible for providing independent
scrutiny of fiscal projections from HM Treasury. Quite rightly,
their plans for the OBR aim to ensure the separation of inherently
political policymaking from essentially a-political forecasting.
IMPLICATIONS FOR
THE OFFICE
FOR BUDGET
RESPONSIBILITY
20. While the theoretical solution to the
independence problem is clear—separating forecasting and
policy-making roles—the practical implications are more
tricky. The difficulty is driven by interconnectedness of policy
and forecasting. For example, to effectively forecast the likely
savings from the Government's plans to re-assess the eligibility
of Incapacity Benefit claimants, one needs to have a reasonably
strong grasp of the policy detail. For this reason the forecasting
role of individual HM Treasury or HMRC officials is usually just
a part of their mainly policy-focused work.
21. The interconnectedness of policy and forecasting
roles, together with the two sources of bias described above,
dictate four broad models for the OBR according to the weight
one places upon each of the trade-offs:
1. The independence-light model. An independent
but internal OBR, overseeing key discrete choices in the production
of the forecast, which remains owned by HMT
This "cheap and cheerful" option potentially
safe-guards against the problem of top-down bias, although early
question marks over the OBR's unemployment judgements means that
the external perception of this cannot be assumed. The Treasury
Select Committee's active engagement with the appointment of Budget
Responsibility Committee (BRC) would also be necessary to ensure
the external credibility of appointments, given the perceptions
surrounding the Bank's Monetary Policy Committee appointment process.
Further, this model does nothing to prevent
bottom-up organisational bias from creeping into forecasts at
a level of detail much below what the BRC would be able to detect.
In its favour, this option would be cheap and involve no further
institutional upheaval.
2. The minimalist external model. An external
OBR with a small staff, charged with overseeing the forecasting
process, which remains owned by HMT
An externally housed OBR, with the appropriate
appointments process, would immunize the institution from any
perception that it was there to disguise, rather than eliminate,
top-down bias. However, with just a limited staff, the Office
would suffer from huge information asymmetries with the officials
who continue to produce the forecast from within HM Treasury.
It is therefore unlikely that this model can do anything to resolve
the bottom-up bias problem. Indeed, the problem may be exacerbated
with the OBR no longer present within the Treasury building.
3. The seasonal labour model. An external
OBR with a small permanent staff, and HMT/HMRC experts seconded
into the Office over the Budget and Pre-Budget Report period,
while the forecast is done
In order to protect against both forms of bias,
it has therefore been suggested that policy officials might be
temporarily seconded into the OBR, twice a year, to construct
an OBR-owned forecast. However, this model entails serious practical
problems.
Those involved in the forecast have both a policymaking
role, which must be Treasury based, and a forecasting role, which,
on this model, must not be. The fact that those officials responsible
for feeding into the forecast are simultaneously needed in HM
Treasury for their policy expertise during the budget exercise
makes this model problematic. HM Treasury would find it difficult
to operate effectively at Budget time.
4. The full independence model, An external
OBR with a more substantial, dedicated staff charged with understanding
policy in sufficient detail to develop the forecast from a low
level
The weaknesses of the above models imply that
the OBR must be external, substantial and its workforce cannot
be seasonal. The only effective and practical solution to the
problems of eliminating bias from the fiscal projections is therefore
to ensure that the OBR is sufficiently well resourced for its
officials to:
— take on the forecasting role of officials
at an early stage in the process, thus owning the forecast and
eliminating the potential for bias;
— have responsibility for a sufficiently
narrow range of policy, to enable them to get to grips with emerging
policy issues and their likely impact on the forecast; and
— be based outside the Treasury.
22. How many staff would be required to
operate such a model is for others to determine. Nevertheless,
it is clearly significantly more than the current secretariat
of eight, while being many fewer than the hundreds of officials
currently involved in the process in some way. Only with this
level of resource can the OBR as an institution address the full
range of reasons for the failure of the defunct fiscal framework.
23. These arrangements proposed by the SMF
will not be without cost. However, the annual cost of the OBR
must be set against the much longer-term and more substantial
cost of poor fiscal policymaking.
CONCLUSION
24. The SMF argues that a greater level
of institutional separation and independence for the OBR will
be essential to its success as an independent fiscal council.
This means that the OBR must:
— have sufficient staff and expertise to
be originate the forecast from a low base; and
— have sufficient staff to understand the
implications of policy at a detailed level.
ABOUT THE
SMF
25. The Social Market Foundation (SMF) is
a leading UK think tank, developing innovative ideas across a
broad range of economic and social policy. It champions policy
ideas which marry markets with social justice and takes a pro-market
rather than free-market approach. Our work is characterised by
the belief that governments have an important role to play in
correcting market failures and setting the framework within which
markets can operate in a way that benefits individuals and society
as a whole.
26. The SMF is politically independent, and works
with all of the UK's main political parties. Our Board, Policy
Advisory Board and staff reflect this. Our research work is undertaken
by SMF staff; by our wide network of Associate Fellows and Advisory
Board members, and by other experts in their field.
August 2010
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