Damian made a speech today at the annual A Level Economics conference in London, on economic theory & practice and how they relate to his work at the Treasury.
“The Treasury: economics - theory vs practice”
Good afternoon – and thanks for the invitation to be with you.
Treasury ministers talk all the time about the economy, but they are seldom invited to come and speak about economics!
There is an important distinction – but of course the one underpins the other.
It’s the insights of economists that help Governments run an economy: which economic levers to pull, and which measures to put in place.
Those measures affect every aspect of how the country is run –promoting social cohesion, tackling climate change, or putting in place sustainable economic development in deprived areas. Where I work at the Treasury, there are no decisions made that trained economists have not had a hand in.
So thank you for choosing to study economics – and, because at the Treasury, we like to think we get some of the very best economists, thank you for adding to the gene pool!
One of the initially irritating things about studying economics can be that it often seems to bear little resemblance to real life.
But with every passing year since my own A Levels I’ve realised how immensely practical and useful this subject is in the real world – in business, and now in government.
As preparation for today I looked at one of the exam board’s current specification for A Level economics. I was reminded how a few key concepts explain a lot:
- Opportunity cost…
- The production possibility curve…
- The circular flow of income.
Studying economics at A-level puts you in a good position not just to spot a market failure, but more importantly, to say why it is failing.
You learn ...
To distinguish the positive from the normative
to think in terms of conceptual models
You discover ...
that simplifying assumptions are both necessary and dangerous.
And that today's conventional wisdom can quickly become tomorrow’s outmoded judgement.
Looking at the exam specification also reminded me how much has changed in the study of economics. And that gives an insight into some of what we are most concerned about in the Treasury today.
That alongside land, labour and capital, enterprise is a factor of production in its own right.
That “the environment is itself a scarce resource”
That the impact of a minimum wage is not obvious, but a multi-layered issue, especially in an open economy.
At A Level and beyond, the study of economics has both widened and blurred.
We now have a much greater emphasis on behavioural economics.
Advertisers and retail merchandisers have long known about the power of suggestion, the influence of fashion, that what matters is not just what you sell but how you sell it, what shelf you put it on and what it’s next to. Now governments are wise to that too.
It’s why we’ve invested so heavily in one of the most exciting branches of Whitehall, the so-called “nudge unit".
The way we approach data, too, has changed. Econometrics has merged with the much more exciting sounding Big Data, with a hint that the answers to the world’s major questions lie hidden in some dataset, just waiting to be liberated. We could find it, if only we could build a spreadsheet big enough.
That emphasis on data has led to much more interest in the value of knowledge. There’s a growing understanding that the asymmetry of information is at the heart of many a market failure.
So there’s been a lot extra to pack in – because economics is a constantly evolving subject. Of course, as the subject got bigger, something had to give. Before 2007, that something was sometimes the study of economic history.
But those who cannot remember the past are condemned to repeat it...
Following the crash, economics departments started paying more attention again to the past – and in particular, the moments before and after previous economic crashes. History never repeats itself exactly – but the same patterns do appear over and over again.
At the Treasury, we use all these disciplines – micro and macro, classical economics applied, behavioural insights, mega-analyses, and economic history.
Combined, they help us achieve our core aim.
Frederick W Smith, the founder of FedEx, doesn’t really give interviews. When asked once about the source of his success, he took a long pause before replying:
“The main thing is to keep the main thing the main thing.”
Our “main thing”, in the Treasury, is to provide economic security and prosperity for Great Britain.
That’s what the Chancellor states every time he stands up in the House of Commons.
So what is this department, what does it do, and how does it do it?
The prosaic answer is that the Treasury is both an economics and a finance ministry.
But it’s more than that.
It’s also been called the “central citadel of British government”: the place where some of the biggest decisions are made.
In 1900, Lord Salisbury, the then Prime Minister, said that the Treasury, through having “the power of the purse, claims a voice in all decisions of administrative authority and policy”.
It is fair to say that over the past hundred or so years, economic affairs have steadily increased in both complexity and importance; and so, consequently, has the role of the Treasury.
With power comes responsibility – though not always popularity. King James I said that “all Treasurers, if they do good service to their masters”, must be generally hated.
That is for a simple reason. There is never enough money to go round to do what we want to do! In consequence, a lot of the Treasury’s role is saying “sorry, we don’t have enough money to do that”. As students of economics it won’t surprise you that it all boils down to scarcity, choice and cost..
But though the Chancellor and the civil servants may not be able to do everything everyone wants, they make sure they pull all the economic levers at the Treasury’s command...
in order to create sustained economic growth – because it is growth that makes society more prosperous, and affords the public services we all value.
In other words, growth lets us do more of the everything that everyone wants.
One lever the Treasury is not able to pull is the power to set interest rates. That has been taken over by the independent Bank of England.
And there are many other things which are outside the Treasury’s control, especially in the international economy.
But there are some pretty big ones left.
One of the biggest is tax.
Tax is one of the most important sources of revenue for the Government. But, applied in the wrong way, it is also one of the quickest ways to drive away investment and wealth creation, to impede that factor of production, enterprise.
In the world we live in, people and businesses are highly mobile. Set tax too high and they may leave. Set tax too low, and you don’t get enough revenue.
You can also introduce new taxes – but you have to be very careful. In the 17th century we applied a tax on windows – so people started bricking them up. And in the 18th century we started taxing bricks – so they started using fewer, bigger bricks!
The second major lever is public spending.
Unfortunately, we have been spending more than we earn for a number of years. We have a large budget deficit that we need to bring down.
But it’s more complicated than saying “we won’t do x or y any more”. Spending less in certain areas isn’t just politically difficult – it can also be economically counterproductive – especially if it’s investment spending on things that can help economic growth.
Other levers we have are microeconomic rather than macro. They are measures designed to boost growth and productivity – whether for increasing competition in the market, pressing for freer international trade, or creating incentives for people to start up businesses.
So our remit is far-reaching, and it means that we are intimately involved in the work of every other Government department.
Each year there are two really big events where everything comes together and the Chancellor sets out the big economic plans: the Budget, and the Autumn Statement.
The Budget sets out what the Government’s spending and taxes will be for the coming year, and what the forecasts are for Government revenue. Usually it happens in March, but this year we had two Budgets, with the second coming in the Summer, after the election.
Since 1975, there has also been a second annual statement of economic forecasts – the “Autumn Statement”. Under George Osborne as Chancellor, that statement has focused more and more on policies to boost economic growth.
We had the last one a couple of weeks ago – which we combined with a Spending Review, setting out the sums that government Departments were expected to spend over the coming years.
These are major events – the entirety of the Treasury puts in an enormous amount of work to examine closely every aspect of what Government does, and – equally importantly – to think creatively of what else the Government should do.
And there is an awful lot we’ve done over the past five years.
It has all been about “Restoring stability and creating growth”. That has meant a programme of deficit reduction; reforming the welfare state around incentives to work; renewing our partnerships with the world’s fastest-growing economies; changing the tax levers to encourage entrepreneurship and inward investment; and putting in place the right policies to enable sectors outside of banking and places outside of the south east to grow faster and help re-balance the economy.
Economics has been at the heart of each and every one of those decisions.
In the Treasury, it’s equally important to ally your knowledge of economics with knowledge of human nature; diplomacy; creativity; horizon-scanning; and, not least, the courage needed to take some difficult decisions, and to argue your case.
The oldest UK document on how to manage the economy was published in 1178. It says: “The highest skill at the Exchequer does not lie in calculations, but in judgements on all kinds”.
That is as true today as it was then. It’s what makes the Treasury such a fascinating place to work. It’s a place I very much hope that some of you find yourselves, in the not too distant future.
You are studying what has the potential to be one of the most absorbing and varied subjects in the world. The very best of luck to you – and I’d be delighted to take some questions.