Treasury Island
Directory of Strategy
I was recently asked about whether the Treasury had too much power, in the context of its role in the Government’s biggest priorities, by members of the House of Commons Public Administration and Constitutional Affairs Committee. Given the subject is likely to feature prominently in news coverage over the next two weeks, I thought I’d write up a fuller version of my answers.
In one week, everyone in Westminster will be getting the popcorn ready to hear the Chancellor deliver the Spending Review (SR) to Parliament. That includes officials in the Treasury, many of whom will have spent months crafting the narrative and numbers that the Chancellor will deploy at the despatch box to convince the public (and the markets) that the Government has a credible plan to spend their money.
Whole policy agendas live or die by spending reviews; for every winner in the process there’s usually a loser, and the losers rarely keep quiet about it. The malign hand of the Treasury is already being blamed for different spending decisions in the papers, and the SR hasn’t been published yet. I’m sure it’ll continue to be blamed long after.
Because there’s a familiar story about the Treasury: how much power it has, how it focuses on controlling the public finances above all else, and how much “Treasury brain” has damaged the country. Indeed, breaking up the Treasury is a favourite topic of wonks like me.
But even if this SR seems to fit the pattern of a familiar story, I’m not sure it’s true. At the very least, it's not the whole story. Because there's a big hole at the heart of this model of the Treasury. If it really is so powerful, and so obsessively focused with balancing the public finances, then why are public finances so hopelessly out of balance?
No department is an island, not even the Treasury, and looking at it in isolation is where the model goes wrong.
Taking that wider view, both the Treasury and the rest of Whitehall are stuck in a set of dysfunctional institutional dynamics, which are getting worse over time. It’s right to think about the distribution of power between the different bits of government, but wrong to believe that the government’s capacity is zero-sum, and that ‘levelling down' the Treasury will somehow ‘level up’ everywhere else.
Oppositional models and moral hazard
Public spending policy has an oppositional dynamic. There are many areas where departments must get their 'homework marked' by the Treasury. This isn’t a bad thing – formal checks and balances are how we avoid groupthink and bad decision-making. But we’ve let the oppositional model drive us into an unhealthy relationship between the Treasury and spending departments.
Because departments always assume the Treasury will either block or squeeze their spending plans, so have every incentive to inflate bids in preparation for that. And the Treasury always expects bids are inflated, either intentionally or just by optimism bias, and so squeezes them. These positions are both logical, but they drive both parties to extremes over time. Bids get inflated more and more, only to be cut more and more, and so on. Driven to the extremes, everyone loses.
This can be ruinous for spending plans, because of how the public spending framework embeds the kinds of 'moral hazard' that creates catastrophic risk in the financial system. The Consolidated Budgeting Guidance allows departments broad discretion in how they spend their money, with some checks and balances – the principle is that they’re allocated a whole budget, and must manage competing pressures within it, like any other organisation. But the same guidance doesn’t allow the Treasury to let a department “breach” its control totals, i.e. to knowingly overspend on their budget allocation. So if departments look like they’re going to mutiny and overspend, HMT must bail them out.
With an effectively unlimited backstop for their spending plans, departments have little incentive to really try and get good value for money. Instead, they can focus on funding their own priorities and always return to the Treasury to pay for whatever else they need. In turn, this drives the Treasury’s micro-management of individual spending items, because the incentives aren’t there for departments to effectively manage the whole envelope. The saying “when you owe the bank a million dollars, that’s your problem. When you owe the bank a billion dollars, that’s the bank’s problem” comes to mind.
Power imbalances
Although the Treasury runs some of the key processes that administer the country, they are hopelessly outnumbered. It may seem like the Treasury holds all the cards in any spending negotiation, because it sets the timeline and terms of the exchange. But it’s incredibly small – meaning teams of a dozen officials can be trying to manage all the financial and operational information of departments with orders of magnitude more staff and budgets into the tens of billions. It’s easy to see how that drives a kind of fortress mentality, the sense of being a small island in a vast sea.
And in these discussions of where the real power lies in public spending, the Prime Minister is curiously absent. No10 is also hopelessly outmatched by the number of staff, the data and expertise of departments to drive a real strategy. Often, it turns to the Treasury to outsource analysis – relying on their understanding of where the money is going and the policies it buys.
Maybe this leads to bad decisions, but there’s no reason those are only unjustified cuts. It is a lot easier for the Treasury cancel a programme that it doesn’t understand than it is to try and fix it, but it’s equally as easy to just throw money at the same programme and forget about it. The asymmetry of power risks over-simplifying arguments about public spending, but not necessarily in the favour of Treasury-brain biases.
Following the money
One area where most people agree is that the Treasury has the wrong model of what matters. The trouble is that once you dig under the surface of what most people want it to focus on, it always becomes a metric which justifies spending more on their personal pet projects, and rarely (if ever) would help make genuine cuts elsewhere. You can see where that logic takes you...regardless of what variables it picks, the size of the state looks likely to keep increasing.
But there are some areas the Treasury undervalues which would help it get a grip:
- A clearer theory of what drives long-run economic growth – all the problems with public finances are easier to manage if the country is richer.
- A focus on cost-reduction, both for consumers and the State – the Treasury has taken its eye off the ball on cutting the cost of living, or why infrastructure and energy projects have become so expensive.
- And, counter-intuitively, recognising where many of the policies used to get good value for money actually do the opposite.
These are all vital, but when the work is so driven by the cycle of fiscal events, change is unlikely.
Legitimacy
The Treasury might have too much power, or use it in the wrong ways. But its objectives are legitimate ones. For most of the public, their main contact with the state is when they pay taxes every month, or when inflation erodes their paycheck, or interest rates grow their mortgage payments. They know what it costs them.
Last year I wrote that the Treasury is the only department which seriously thinks about the cost of public spending. It’s the only part of Whitehall which is on the side of the contributors; the taxpayers who pay for it. After over a decade of stagnant wages, with tax burden at a post-war high, HMT isn’t having much success. You would be amazed at how many terrible ideas for spending public money still only get stopped because the Treasury says so – rarely does anyone else in the system have an incentive to call waste out for what it is.
Once you dig into it, many of the Treasury’s loudest critics just want it to spend much more, and don’t want to be the ones who count the cost. But however big the envelope, someone is always going to make those trade-offs and be blamed by people who wanted them to do it differently.
We owe the Treasury a proper appreciation of why it works the way it does, before we work out how to change it.