26 Jul 2017

Good News, Bad News. The Treasury has more influence over Brexit but less on the deficit

D324EF05-957D-4517-8E3C5B6883AF478F.jpg

For the second time in a matter of months, Whitehall is faced with an extended period without Parliament to factor in to its considerations. Unlike the election period, however, officials do have functioning ministers and hence can take meaningful decisions. The unexpected outcome of the result on 8 June has already had a significant impact on the power map within government. The Chancellor personally and the Treasury institutionally is in a different place to where it stood in advance of the hustings and where it would have been if Theresa May had won with the thumping majority that she (and most other people) anticipated when the decision to call the ballot was made. This realignment of authority, essentially from No 10 to No 11, is already making a serious difference.

The election has rendered the Chancellor and Treasury much more influence over Brexit

If Mrs May had managed any substantial victory at the general election then the chances are that Philip Hammond would have been offered a swap of roles with Amber Rudd, the Home Secretary, and if he did not care for that exchange then he would have left her administration. Ms Rudd does not hold very different views on Brexit to Mr Hammond but would have been perceived as more of a creature of Mrs May personally, and less keen to attempt to force the Brexit discussion in a direction different to that which Number 10 itself wanted to see taken. The Treasury would doubtless have still been on the softer end of the harder versus softer Brexit debate, but it would not have had that loud a voice.

Once the fabled exit poll was released on election night and rapidly vindicated by the early results, matters changed dramatically. Mr Hammond became unsackable unless the Prime Minister wanted to invite her own departure as well. His price for staying in place was a centre stage role in the Brexit dialogue and the freedom to make his case far more openly that he had been permitted previously.

He took the opportunity of what turned out to be a Mansion House breakfast to make his argument, with a notable focus on the advantages of maintaining a relationship with the European Investment Bank (and through it the European Investment Fund) even after the UK has withdrawn from the EU. His leadership has enabled colleagues to make similar assertions with regards to other EU agencies such as Euratom, the European Space Agency and the European Medicines Agency. The business community has found its views being courted once again, particularly on migration after Brexit.

In all of this, the process has been hugely helped by the very cordial working relationship that exists between the Chancellor and David Davis, the Secretary of State for Exiting the European Union. Mr Davis comes from the Leave camp but his opposition to the EU relates to political sovereignty and democratic accountability and not hostility to immigration or any ‘Little Englander’ isolationism.

He is also a pragmatist and a realist when it comes to the complexity of negotiating the UK’s exit. He is fully aware that there will be a hefty ‘divorce’ bill as part of the bargain that ultimately opens up a route to a wider rather than a narrower Free Trade Agreement, and that either refusing to pay up a penny or simply tumbling out of the EU with no arrangement of any kind would be very dangerous. Any Davis/Hammond pact on Brexit will command the support of the rest of the Cabinet. Mrs May can either decide to live with that consensus or become a victim of it if she attempts to resist it. The evidence so far is that she would rather be in office with a lot less power than not in office at all.

So although not formally stated as such yet, the emerging formula for Brexit on the UK side is there. Substantial compromises (even on migration) will be made to secure a divorce settlement and then a transition outcome that will last at least two but most likely three years. It will involve the UK as a de jure or de facto member of either the European Economic Area or the European Free Trade Association but not the Customs Union until (most likely) March 2022. This in turn will buy the time in which to negotiate the more comprehensive agreement that will be established after that date. Any conclusion of this kind will be considered by the Chancellor and Treasury to be a relative victory.

Alas, the short-term domestic economy and the medium-term deficit are not looking so appealing

Although the Chancellor himself is extremely well entrenched, the wider team at the Treasury has seen more change courtesy of the post-election reshuffle than has been true for any other department.

The previous Chief Secretary to the Treasury, David Gauke, who had been at the Treasury for an unusually lengthy tenure of seven years in various roles, was promoted to run the Department for Work and Pensions. His replacement, Liz Truss, was effectively demoted from her position of Lord Chancellor and Secretary of State for Justice, and has little by way of an economics background. The Financial Secretary to the Treasury (Jane Ellison) and the Economic Secretary to the Treasury (Simon Kirby), both of whom were somewhat unorthodox appointments in July 2016 in that neither of them were really ‘numbers people’, were ousted by the electors of Battersea and Brighton respectively. Their replacements, Mel Stride and Steven Barclay, are both new to office of any kind but are more conventional choices in that they have backgrounds in business and financial services. Furthermore, the Commercial Secretary to the Treasury (by recent convention a member of the House of Lords), Baroness Neville-Rolfe, resigned immediately after the election (despite having served for a mere nine months) and has not yet been replaced and it is unclear if the position itself will be abolished.

This comparatively untested set of actors faces a very challenging short and medium-term outlook. Barely a year ago, it was still the central policy of the Government that the deficit would finally be eliminated by 2020 (five years after the initial target set by George Osborne back in 2010) and that objective set the parameters for domestic policy as a whole. Although that objective was seen as quite tough to achieve, it certainly was not dismissed as impossible.

After the referendum result, however, it was abandoned by Mr Osborne himself merely days before he was fired by the incoming Prime Minister and it fell to Mr Hammond to announce that 2022 would be the new 2020, and in his Autumn Statement last November he set out his blueprint for how this would be realised. Yet a mere six months or so later, the Conservative Manifesto revealed that even 2022 was considered to be too testing and that the budget would not actually be balanced and the deficit ended until 2025.

Mr Hammond (and his officials) were not that wild at such an extended deadline and they feared it would be seen as flimsy by the markets and commentators. In return for accepting that the deficit would have to play second-fiddle to Brexit, the Chancellor managed to award himself more flexibility on how he could pursue the new policy with manifesto commitments which diluted previous pledges on limiting the range of taxes that could be increased, rendered the old ‘triple-lock’ on pensions a ‘double-lock’, and made a start on the vast sums spent on the wealthy elderly via a commitment to end the automatic winter fuel allowance and finance social care very differently.

Unfortunately for Mr Hammond, the outcome of the election means that he is stuck with the new 2025 deadline on the deficit but the realities of a minority government and the agreement reached with the DUP means that it is probably politically impossible to increase taxes significantly or to slash popular spending. With growth clearly slower than expected at the start of the year (as confirmed by the initial figures for second quarter GDP today), the deficit will almost certainly be higher next year than last year. The Chancellor’s best hope (and it is more hope than a strategy) is that if he can achieve a softer Brexit outcome quite soon, then investment (which is currently stalled in many sectors) will recover to return growth closer to trend rates and render 2025 a still plausible target for deficit elimination.

Tim Hames
Director General, BVCA


×

Update your login details

We updated our website and supporting systems on 12th December. 

If you previously had an account, please reset your password. If it's your first-time logging in, please register to create an account. For assistance, please contact the BVCA Membership Team

Login